Why business incentives are progressive at the local level, but only to a limited degree

In this post, and a series of subsequent posts, I will consider how different types of economic development programs affect lower income versus middle income versus upper income groups.  This topic is considered in chapter 8 of my book Investing in Kids.

I will assume, because of the large and rising inequality of incomes in the U.S., that if a program provides a greater proportion of benefits to the poor compared to the middle class, or to the middle class compared to upper income groups, the resulting reduction in income inequality is a point in the program’s favor. However, we must also consider how the distribution of effects across different income groups affects a program’s political feasibility. If only the poor benefit from the program, and the program has relatively large costs for all other income groups, the program may not be politically sustainable.

Today’s post will focus on business incentives.  An example of the business incentives I am considering would be property tax abatements, under which a new branch plant, or a plant expansion, or a new business, might apply and be granted the right to pay below normal property taxes for some period of time.  The rationale for the business incentive is the belief that for some percentage of the business incentive awards, the incentive tips the location decision in favor of this state or local area.  As explained in a previous post, this tipped location decision will lead to local employment growth that will raise local employment rates and wage rates and thereby raise earnings.

Business incentives’ effects on different income groups in the local economy largely depend on how these incentives affect the earnings of different income groups.  I consider two strands of research:  research on how well-designed business incentives affect location decisions and thus local employment growth; and research on how local employment growth affects the earnings of different groups. Based on these two strands of research, I calculate effects of well-designed business incentives on different income groups.

I find that business incentives have “progressive” effects on the income distribution. That is, the net gains in income, as a percent of income, tend to be greater for lower income groups than middle income groups, and greater for middle income groups than upper income groups.

However, business incentive effects on the income distribution are only “modestly” progressive.  All groups gain, and the net percentage gains do not vary dramatically. In fact, the dollar gains in income from business incentives are less for lower income groups, but loom larger in percentage terms because lower income groups have such low starting incomes.

As we will see in subsequent posts, business incentives’ distributional effects differ dramatically from early childhood programs. Compared to business incentives, high-quality early childhood programs have benefits that skew much more to lower income groups.

Why aren’t business incentive effects on different income groups more progressive? Effects on the poor are modest because the poor have many labor market problems. Simply expanding labor demand for everyone does not address the problems that many of the poor have with low job skills. As a result of low job skills, many of the poor are not able to take full advantage of the more and better jobs provided by local job growth. Even when the poor work more in a growing economy, their lower than average wages limit their earnings gains.

More progressive effects on the income distribution can be achieved by programs that more directly upgrade the skills and wages of the poor. This can be achieved by many human capital programs, but more cost-effectively through early childhood programs, which intervene when skills are more malleable.

About timbartik

Tim Bartik is a senior economist at the Upjohn Institute for Employment Research, a non-profit and non-partisan research organization in Kalamazoo, Michigan. His research specializes in state and local economic development policies and local labor markets.
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