Tax Incentive Evaluations Help States Limit Fiscal Uncertainty, Improve Effectiveness

Even as the pandemic forced states to shift their policy priorities and grapple with the economic downturn during the 2020 legislative session, governments continued to enact major reforms to economic development tax incentives. And as more states across the country implement processes to regularly produce high-quality, rigorous evaluations of such programs, lawmakers increasingly use findings from these reports to inform policies that ensure that incentives are effective, accountable, and fiscally sound.

For example, New Jersey previously lacked a process to regularly evaluate its flagship economic development incentives. One-time incentive reviews published in 2018 and 2019 identified design, administration, and cost issues that guided several years of debate among policymakers and stakeholders. In December, lawmakers reached an agreement on how to replace these programs. The legislation creates and amends incentives for job creation and retention, real estate development, and other activities while addressing two weaknesses of the state’s old programs. First, it places an annual cost limit, or cap, on yearly award amounts for each program and limits their total costs for a six-year period. If the limit is not reached in the first six years, uncommitted credits may be authorized during a seventh year. Second, the largest programs are subject to biennial independent evaluations to study their effectiveness.

New Jersey’s preliminary reviews led to substantive reforms to the state’s incentive portfolio. In addition to the new incentive programs, legislators implemented a recurring evaluation process, taking initial steps to ensure that lawmakers have current information about how well incentives are achieving their intended goals. Experiences in other states can help New Jersey plan for its first evaluation under the newly established process, proactively address common issues, and build on its early success in connecting findings to policy change.

First-time evaluations look toward future reviews

Hawaii, Kansas, and Montana joined the growing list of states that have begun releasing evaluations on a recurring schedule. Among other findings, these initial reports suggest improvements intended to strengthen the evaluation process and analysis during subsequent review cycles.

Hawaii’s first report suggests establishing clear purposes and assessment criteria for new and existing expenditures to help measure success. Kansas’ Legislative Division of Post Audit made similar recommendations in its angel investor tax credit report.

Montana’s revenue interim committee, which reviews select incentives, took steps to ensure that future lawmakers continue to receive valuable information about the use of various credits and how they function. Among the four draft bills adopted for introduction during the legislative session, one measure makes the review process permanent.

Policy changes curb future fiscal risk and strengthen incentive design

As lawmakers implement recommendations from evaluations, they demonstrate how these reports can serve as valuable policy tools to reduce budget risks, improve effectiveness, prioritize state spending, and clarify details.

For instance, a 2019 report on the Nebraska Advantage Act, the state’s signature business incentive portfolio, highlighted design deficiencies that left the state vulnerable to fiscal risk. Policymakers used these findings to help craft its replacement, the ImagiNE Nebraska Act, with an annual cost limit to address one of the previous program’s flaws.

Evaluations can also help states better direct investments to projects that are more likely to succeed and therefore provide a better return on investment. Recently enacted legislation in Mississippi seeks to do just that—now, as part of the award process, certain projects must provide evidence that they can meet specific economic development goals. The University Research Center, which conducts evaluations of the state’s incentives every four years, reported that Mississippi provided incentives to projects that were likely to fail at the outset. The bill also specifies how the state may recoup awarded funds if recipients do not meet agreed-upon performance measures.

Evaluations often include information about the cost or benefit to the state and can assist in prioritizing spending. In Washington, Governor Jay Inslee (D) signed legislation to extend a sales and use tax exemption for large private airplanes, originally set to expire in July 2021. An evaluation of the exemption found that it likely generated between $1.8 million and $3.3 million in new statewide tax revenue each year in addition to new jobs. Conversely, Gov. Inslee vetoed an extension of another exemption and several other measures, citing concerns over the pandemic’s impacts on the state’s budget and lost revenue.

Additionally, evaluations help policymakers tweak incentive design details to ensure that they are effectively and efficiently achieving their goals. For example, based on recommendations from a 2019 Virginia Joint Legislative Audit and Review Commission report finding that the recyclable materials processing equipment tax credit helps businesses comply with environmental regulations, lawmakers expanded which purchases are eligible for the credit. And although beyond the scope of Louisiana’s regular evaluation process, a recent Legislative Auditor evaluation resulted in new regulations that clarify which jobs are eligible for a program to encourage businesses to locate or expand operations in the state. And finally, an interim study of the Colorado Office of the State Auditor’s reports produced a measure that requires all newly introduced tax expenditures to include a purpose statement and defined metrics to make it easier to evaluate how well they are meeting their goals.

Evaluation findings produce iterative changes to incentives

In some cases, the same evaluation of a program can inform policy decisions over several years, particularly as fiscal and economic conditions evolve and funding priorities shift. The District of Columbia Office of the Chief Financial Officer’s (OCFO) 2018 evaluation of the Qualified High Technology Company (QHTC) program, one of its most costly economic development incentives, noted that several companies had received significant credits while not demonstrating new economic activity within D.C. After making initial cost reductions to QHTC in 2019, the fiscal year 2021 budget scales it back further, once again citing OCFO’s 2018 evaluation findings.

As the reforms in the District of Columbia and other jurisdictions show, even in a year of unprecedented challenges, policymakers have continued to rely on evidence from evaluations. Moving forward, these tools will be of greater importance as the economy recovers and states must safeguard their budgets.

Josh Goodman is a senior officer and Khara Boender is a senior associate with The Pew Charitable Trusts’ state fiscal health initiative.