Government agencies offer numerous economic incentives to promote business expansion. These include tax abatements, infrastructure assistance grants low or no interest financing and free land.
Though effective, these programs come at a significant expense to taxpayers. Critics argue that subsides create market distortions which leave consumers worse off than before the subsidies were in place.
Tax Incentives
Tax incentives provide businesses with reduced operating expenses and encourage them to invest or create jobs more freely, as well as fulfilling specific economic development goals set by governments. Tax credits could provide one means by which to curb sprawl by offering tax incentives to developers who build new housing units in already developed areas; or they could promote open space preservation and the conversion of historic buildings into affordable housing projects. Evaluating whether incentives fulfill their goals is difficult. According to Timothy Bartik, a researcher and professor from the University of Central Arkansas, business tax breaks and cash grants contribute an estimated 11% towards economic growth locally. He suggests replacing these types of incentives with block grants instead as these would eliminate discretionary benefits and offer more practical, realistic, transparent ways of encouraging economic expansion.
Assessing the efficacy of tax incentives requires considering their ability to help achieve specific outcomes, such as revitalizing neighborhoods or communities, creating low-income housing or encouraging sustainable tourism. A key part of ensuring their effectiveness is making sure incentives reach precisely where they’re needed instead of general target groups or industries.
Tax incentives can be an effective tool to increase tax efficiency; however, they can have unintended repercussions if they are overly generous or poorly designed. When countries or investors subsidize activities that don’t benefit their economy directly, a race to the bottom can ensue resulting in inadequate incentives that don’t deliver real value – like investing in expensive refueling facilities in Sierra Leone to avoid tax breaks on imported raw materials).
To avoid this happening, governments can utilize evaluation resources to ensure any investment they promote is worth its while. According to estimates by the Institute for Research on Public Policy, it may take five years or longer for an investment to become profitable without considering subsidies and costs associated with other forms of assistance. In addition, governments should avoid introducing taxes that will become difficult or burdensome over time and work towards decreasing existing ones as much as possible.
Job Creation
Incentive programs are an invaluable asset to local governments when it comes to encouraging business investment, job creation and economic development. Such incentives typically take the form of tax credits, cash grants, property and sales/use tax abatements or rebates, utility rate reductions, land concessions, low or no interest financing and other resources that help promote technology innovation, research & development activities, entrepreneurship expansion as well as advancement of national social policy goals such as equity advancement or sustainability among others.
Harnessing these incentives effectively is no simple feat, however. Cities are coming under increased scrutiny for their reliance on incentives, which has an impactful yet affordable economic growth impact. Cities must use incentive policies as tools for economic development that drive meaningful yet affordable economic development in their localities.
For this to work effectively, city leaders must carefully tailor their policies to their particular social and economic circumstances. Indianapolis is currently shifting incentives toward high-wage, high-growth industries that don’t require bachelor degrees; thus broadening its economic base while decreasing income inequality and increasing mobility for its residents.
Cities must also carefully consider how they plan to distribute these incentives, with Bartik recommending that 60 percent of total incentives should take the form of tax breaks in order to ease household taxes, an important factor for local politicians. He further suggests targeting incentives at firms producing tradable goods and services regardless of size; and using savings from reduced reliance on long-term incentives towards public infrastructure projects or skills development programs with greater job multiplier effects than tax breaks.
Baker Tilly’s Government Incentives Team provides clients with assistance to identify and secure government grants, tax credits and R&D incentives to support their project locations. We help our clients to understand the requirements and sensitivities of each government entity before providing all required application materials for submission. In addition to that we also create customized economic impact reports to meet each program’s “but for” requirements and quantify taxpayer returns on investments.
Business Expansion
Business expansion occurs when a company grows by adding additional locations, recruiting more sales staff, increasing marketing or offering new products or services. Such activities can increase profits as well as lead to increased investments in capital equipment and real estate assets. Local governments provide various economic incentives to attract investments, including tax abatements, revenue sharing arrangements, grants, infrastructure assistance programs, low or no interest financing solutions, free land and other forms of financial resources. Governments invest in these programs with the expectation that they will stimulate broad economic activity and boost consumer spending and local tax collections, but these benefits may not always materialize; there may also be unexpected outcomes due to government incentives.
Governments should carefully weigh the costs and benefits of any incentive offerings they make to businesses, prioritizing incentives that generate the greatest economic impact; such as those targeted towards companies creating high-paying jobs versus lower wage businesses with more widespread spillover effects in a community; thus they should receive larger incentives than lower wage firms.
Many states and cities rely on business incentives to drive economic development in their local communities, providing funding for infrastructure projects, skill training courses and custom business services which in turn spur growth in economic activity and job creation. It is essential for governments not to overspend in order to avoid undermining quality public services.
State and local governments devote billions to firm-specific business incentives each year, comprising an extraordinary portion of their budgets. According to research by Slattery and colleagues, state and local governments use these incentives as part of an investment promotion effort, but don’t always achieve their desired outcomes; rather incentives tend to flow to a small collection of large firms opening offices in new locations – further clouding evidence regarding effectiveness.
The authors suggest that to increase tax efficiency effectively, block grants such as those earmarked for infrastructure projects and skills development are the most cost-effective means of doing so. They provide greater benefits and make better use of place-based policies.
Investment
Governments can offer many incentives to encourage private businesses to invest in their territory, including tax breaks, cash grants and low-interest financing. Such incentives can boost the economy by encouraging investment in projects which would otherwise have been unprofitable – but too often can cause overinvestment in certain sectors and dilute resources away from more productive uses – so when designing their incentives policies governments must carefully weigh both benefits and drawbacks when designing policies to promote investment.
Governments should make use of incentives designed to increase tax efficiency as a powerful tool in improving economic development. Such incentives can reduce tax complexity while improving compliance rates among corporate taxpayers, encouraging innovative companies to form and creating jobs within an economy. However, any such tax incentives must be balanced against transparency and integrity when administrating business taxes.
Economic Development Agencies (EDOs) use tax incentives to entice the right businesses to an area and offer financial incentives as an inducement to invest in local communities and create jobs. By following best practices, EDOs can maximize the benefits of tax incentives for their communities.
Government economic-development incentives are estimated to reach nearly $85 billion each year, with large corporations accounting for 90%. Some smaller businesses can still take advantage of them however. Alongside traditional incentives like cash grants and tax credits, governments also provide nonfinancial benefits like infrastructure development or training that target specific industries to create clusters such as BMW did when opening its first automobile assembly plant in South Carolina in 1992.
Investment incentives can be powerful tools in driving economic growth, yet managing them can be tricky. A number of factors impede their effectiveness including policy instability and an elevated country risk perception that raises the hurdle rate for investment. Furthermore, these risks reduce investors’ trust in specific tax incentives, leading them to discount their value over time.