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July 12, 2018

Lessons from state-level evaluations of economic development incentives

Jul 12, 2018

Lessons from state-level evaluations of economic development incentives

Illinois state and local governments spend or forgo significant tax revenues to spur and support economic development. But we have a limited understanding of the value of those investments. This challenge extends to metropolitan Chicago, a 2017 Pew Charitable Trusts report found Illinois lags other states in requiring regular evaluation of its economic development incentives. In recent years, 27 states and the District of Columbia have instituted measures requiring some form of evaluation, offering a range of potential models and lessons. Recent national reforms have sought to improve decision making around incentives. In August 2015, the Governmental Accounting Standards Board (GASB) issued GASB statement 77 requiring state and local governments to disclose new tax expenditures that affect their ability to raise revenue. The measure will provide valuable information on some incentives, but further reforms could enhance accountability and yield more performance-based approaches.

Amid lackluster economic growth and increasing budgetary pressures, the State of Illinois may consider reforming its approach to fostering economic development. Addressing Illinois and metropolitan Chicago’s prolonged slow economic growth will require prioritizing limited resources to programs that meaningfully support broad-based opportunity. Transparency and rigorous analysis could strengthen metropolitan Chicago’s global economic position by supporting strategic planning, coordinating and prioritizing investments, and improving access to data and information. The region’s current comprehensive plan, GO TO 2040, emphasized this concept, and the draft ON TO 2050 plan -- available for public comment through August 14, 2018 -- underscores this recommendation. Since the adoption of GO TO 2040, CMAP research has highlighted relevant strategies implemented in other states, as in the 2014 report Reorienting State and Regional Economic Development: Lessons Learned from National Examples. The report highlights policy changes in Oregon and Washington to improve the transparency and accountability of incentives.

This CMAP Policy Update follows up on implementation of those policy measures in the Pacific Northwest, where progress has been modest. However, these states demonstrate how applying expiration deadlines (known as sunsets), specifying performance metrics, and conducting rigorous evaluations can support timely, informed policy choices. While this update focuses on state-level programs, lessons on enhancing such evaluation apply to all levels of government making economic development investments.

Oregon reviews incentives through the appropriations process to understand cost

Over the past decade, the State of Oregon has gradually institutionalized regular reviews of tax credits -- including incentives for economic development -- as part of its appropriations process. Although narrower in focus than those in other states, Oregon’s evaluation laws have led legislators to allow 33 tax credits to expire and to restructure five others. Beginning in 2009, the state enacted sunsets on most individual and corporate income tax credits so that each will expire every six years unless lawmakers act to renew it.

A law passed in 2013 required the Legislative Revenue Office (LRO) to prepare biennial reports on the purpose, outcomes, and rationale of expiring tax credits. By considering credits with similar purposes in the same year, lawmakers can make substantial changes based on their comparative design and results. For example, in 2015, the legislature consolidated two credits for childcare expenses with different eligibility requirements into one means-tested program -- a policy option identified in the LRO’s first biennial report. Oregon now also requires the chief sponsors of new or expanded tax credits to submit a statement of public purpose and estimated revenue impacts for consideration during the legislative process.

The table below summarizes Oregon legislative actions as a result of tax credit reviews completed since enacting sunsets in 2009. While they provide valuable analysis of program design and administration, LRO reviews often lack rigorous estimates of incentives’ full economic impact, particularly for existing programs without specified performance measures. Statutory sunsets and written reviews have encouraged legislators to review the relative costs and benefits of tax credits in part because revenue forecasts are made under the assumption that expiring credits will not be renewed. The House and Senate Revenue committees -- as well as the governor’s budget proposal -- must consider incentives as indirect spending and make specific budget allocations for their renewal.

 

The LRO reviewed four tax credits intended to support economic development in its 2017 biennial report: a Qualified Research Activities (R&D) sales tax credit and three property tax credits that expand benefits in some of the state’s Enterprise Zones. While it included useful information and several options for improvement, the LRO report also cited a lack of data and metrics as limiting its ability to produce rigorous economic analysis on some credits. For example, although Oregon is among the top 10 states by share of GDP invested in R&D activities, the LRO’s use of 2014 tax return data could not establish any behavioral response to the R&D tax credit among businesses.

The State of Oregon has a strong record of legislative action based on LRO reviews, but further progress may require expanding the office’s mandate and resources for rigorous analysis. Current evaluation laws focus exclusively on state income tax credits even though the state provides for numerous other incentives. This statutory focus excludes other public investments in economic development, not even taking into account property and sales tax expenditures. For example, in some Enterprise Zones, the state offers additional tax incentives to affect the cost of capital and labor related to rural facilities, tribal reservations, and electronic commerce. While these tax abatements can have fiscal impacts on local governments, LRO only evaluates related state income tax credits per statute and does not publish their value due to confidentiality concerns.

Business Oregon -- a state agency -- publishes some information about these programs, but LRO’s current mandate excludes reviews of property, sales, and utility tax incentives. For example, nine businesses have received a total of $102.9 million in local property tax exemptions since 2014 through the Long-term Rural Facility Enterprise Zone program (see table below.) The table below shows the property taxes exempted under the program. Due to statutory and data restrictions, LRO could only review the rationale for Enterprise Zones as an economic development tool and potential lessons from existing academic literature, without analyzing evidence on their full impact in Oregon. Such evaluation could further inform the state’s decision-making.

Ongoing evaluations in Washington result in improved process but limited reforms

In the State of Washington, evaluation requirements have provided insights on the efficacy of incentives. However, this knowledge generally has not resulted in legislative action because many existing programs lack expiration dates that might spur final decisions. Under a 2006 law, a bicameral Joint Legislative Audit and Review Committee (JLARC) reviews tax preferences and provides recommendations to the state legislature on continuing, modifying, or ending each policy. JLARC’s non-partisan staff has evaluated more than 250 tax preferences -- including deductions, credits, deferrals, or preferential rates of a state tax -- in its first 10-year cycle.

JLARC works to determine whether each tax preference is on track to meet target outcomes, such as abating air pollution at Washington’s only coal-fired power plant. In some cases, the commission uses economic modeling to compare the results of such incentives to alternative strategies -- for example, reconsidering the rationale of incentives for data centers and film production. The table below provides an overview of legislative actions since 2007 compared with JLARC’s recommendations.

Although seen as a national leader in evaluating its tax preferences, the State of Washington has taken limited legislative action because of JLARC’s evaluations. Ongoing reform initiatives are intended to improve the depth and sophistication of JLARC’s reviews and the legislature’s considerations of JLARC findings. Many JLARC reviews make specific recommendations for the legislature to clarify an existing program’s objectives, metrics, and targets -- for example, those of a 1970 tax credit for state-chartered credit unions. A 2017 peer review by the National Conference of State Legislatures also found that Washington’s unclear target outcomes and the high volume of tax policies to be studied each year continue to limit some analysis. For the next 10-year cycle, the Citizen Commission that oversees this work has already exempted dozens of tax preferences from evaluation because officials deemed them consistent with principles of good tax policy, such as avoiding double taxation. Despite these process improvements, statute still exempts many relevant tax preferences from review, such as sales tax exemptions for equipment used in manufacturing or research.

Under a 2013 law, any new tax preference must include a statement on its public policy purpose and how the state will assess its performance. To better connect evaluations to policy choices, the legislation also applies a 10-year sunset date to any new tax preference. However, these requirements do not apply to most of the state’s nearly 600 existing tax preferences. Ongoing reforms -- such as enforcing sunsets on all preferences -- could help to prioritize JLARC’s focus and resources on incentives for economic development and other high-priority tax expenditures.

Analysis often finds limited benefits from economic development incentives

Many state and local governments offer financial inducements to businesses in hopes of attracting or retaining jobs, increasing wages, inducing development, and generating revenue. But many incentive programs can result in public expenditures or foregone revenue for limited economic gain. This assistance can take many forms, such as tax abatements, credits, and deferrals; non-tax cash grants and loans; or other subsidies including infrastructure investments, fee waivers, and land write-downs. While approaches differ widely, research shows programs often lack a strategic approach, favor large companies, and yield marginal increases in employment, wages, or investment in research. Well-structured incentives can support some regional and local planning goals. Reinvesting in infill sites, encouraging mixed-use development, remediating brownfields -- performance-based approaches can help make the best use of limited resources in achieving these and other goals.

Some of the challenges may stem from the lack of a broader economic development strategy and planning. For example, governments frequently sign ad-hoc financial deals to compete with neighboring jurisdictions over specific businesses. However, numerous studies have found that incentives play only a minor role in businesses’ relocation and expansion decisions, especially when benefits extend 10 or more years into the future. Instead, fundamental needs such as a consumer market, infrastructure, and the supply of skilled workers and other business inputs play a central role in location or expansion decisions. Overreliance on incentives can generate inefficient intra-regional competition that rewards businesses for activity that would have taken place anyway. Together, relevant research shows that incentives are generally incidental rather than instrumental to expanding employment and spurring economic growth.

Despite increased scrutiny from researchers and the public, incentives remain a core component of state and local economic development policy. Researchers have estimated that state and local business incentives nationally have an annual cost between $45 billion and $65 billion in 2015 dollars. The Upjohn Institute has estimated that incentives to “export-base” industries -- those that sell their goods and services outside the regional economy -- represent about 30 percent of average state and local business tax collections. These data also suggest that spending on such incentives has more than tripled since 1990, both nationally and in Illinois. However, while increases on incentive spending slowed nationally after 2001, Illinois continued to raise state and local incentive spending by approximately 30 percent between 2007-15.

These programs are major budget commitments that affect revenue for public services -- such as high-quality education and infrastructure -- that are critical to economic competitiveness. Yet, incentives for economic development often fall outside the scrutiny of a regular budgeting process, where policymakers must consider trade-offs. Governments often structure incentives as tax expenditures -- special exclusions, exemptions, deductions, or credits that may appear to lower tax revenues rather than increase spending. Businesses can qualify for these subsidies automatically based on criteria in the tax code or at the discretion of state and local officials. These programs generally do not receive the same scrutiny as other budgetary expenditures. Instead, governments should establish policies that require performance evaluations of incentive programs and use results to extend, adjust, or discontinue particular incentives.

Like other parts of the country, the State of Illinois provides a wide variety of incentives for economic development but does not routinely monitor whether all incentives achieve their intended goals. The state has enacted legislation that requires tax credits, exemptions, and deductions created after 1994 to expire every five years, but has also approved blanket extensions of incentives set to expire in 2011, 2012, and 2013. If maintained, these sunsets provide a starting point for establishing a plan to regularly evaluate and enhance incentive programs. For example, in 2017, the General Assembly revived the expired Economic Development for a Growing Economy (EDGE) program after a brief sunset. The program subsidizes some training costs and returns to participating businesses the personal state income tax withheld from new employees. The legislation tried to address some critiques of the program by enacting new caps on tax credits, stricter eligibility requirements, and increased awards for projects in “underserved areas.” However, these changes did not result from a rigorous evaluation of the program’s full economic and budget impacts. Without accompanying evaluations to guide policy choices, Illinois’ sunsets have not yet spurred improvements at the scale or scope seen in other states.

Looking ahead

In today’s environment of constrained public funding, governments should evaluate and weigh economic development programs with the same scrutiny as other budgetary expenditures. Wide variation in incentive programs and evaluation laws nationally reflects a need for comparable, timely, and relevant data to inform state and local decision making.

Evaluation laws in Washington and Oregon provide valuable lessons for the State of Illinois. State and local officials should draw on regular and rigorous evaluations of a program’s full impact when deciding whether to end, extend, or modify it. The state’s longstanding sunsets law provides a basis for enacting further reforms, such as requiring statements on a program’s public policy purpose, potential fiscal impact, and performance benchmarks. Implementing stronger transparency and accountability standards will also require reforms to collect and publish comprehensive data on economic development incentives and their outcomes.

CMAP will follow the progress of evaluation laws regarding incentives for economic development and high-priority tax expenditures. Innovative strategies implemented in other parts of the country will help to further guide implementation of ON TO 2050 strategies to promote responsive, strategic economic development.

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