The national perspective: are business incentives a zero-sum game?

Most of this blog’s posts on business incentives and early childhood programs have taken a state and local perspective. I have focused on whether these policies produce “local economic development benefits”, which are defined as higher per capita earnings for residents of that state or local area. This focus ignores effects on per capita earnings of U.S. residents outside that state or local area.

This post and several future blog posts will consider business incentives and early childhood programs from a national perspective.  The national perspective is discussed in chapter 10 of Investing in Kids.

This post focuses on business incentives. It is often asserted that business incentives are a “zero-sum game”. The argument for business incentives being a zero-sum game is that any increase in state or local business activity due to a state or local area’s business incentives will lead to a corresponding reduction of business activity in other state or local areas.

The obvious case in which this argument makes sense is a company choosing a location for a new branch plant.  A state or local area offering a business incentive to that company may succeed in tipping the location decision towards choosing that state or local area. However, if the branch plant had not chosen the state or local area offering that incentive, it would have chosen some other area.  The net national increase in economic activity would seem to be zero.

However, the zero-sum argument applies more broadly than just the case of business incentives for new branch plants. This argument can also be applied to business incentives offered to new small businesses, or to encourage business expansion. Any additional business activity competes with other businesses for sales. If a business incentive induces some new business activity or business expansion to increase its output and market share, this may reduce the market share of other businesses.

For example, suppose a state or local area adopts a business incentive package that is successful in encouraging the creation and expansion of new local high-tech businesses that sell to a national market. That success may reduce the market share of high-tech businesses in other state or local areas.

In chapter 10 of Investing in Kids, I show that this zero-sum game is “mostly true”, but not entirely so. Specifically, I estimate that it is 79% true.

Business incentives lower business costs. This reduction in business costs should induce some overall increase in national business activity.

However, this increase in national business activity due to business incentives is less than the increase in state and local business activity due to business incentives.  At the state and local level, business incentives can have larger effects because the incentives can affect business activity not only by inducing new national activity, but also by changing the location of business activity. Also, it turns out that it is easier to change the location of business activity than to induce new business activity.

As reviewed in chapter 10 of Investing in Kids, the effects on national business activity of business incentives are about one-fifth of the effects of business incentives at the state or local level. In other words, although state and local business incentives are mostly stealing jobs from other states, they also do induce some new national business activity.

The implication is that typical high-quality business tax incentives in the average state do not make economic sense from a national perspective. Recall that I estimated that for each dollar a typical state invests in a high-quality business tax incentive, the resulting increase in the present value of state residents’ per capita earnings is $3.14. In other words, the ratio of state economic development benefits to costs is 3.14.

But at the national level, the increase in business activity from business tax incentives, and hence the increase in per capita national earnings, is less than one-fifth as great. At the national level, for each dollar invested in business tax incentives, I calculate that per capita national earnings increase by 65 cents.

This implies that investing in business tax incentives does not make sense from the perspective of the average American household. The average American household would pay more for such business tax incentives than the return in the form of increased future earnings.

This raises the question of what, if anything, federal policy can and should do about business incentives.  This will be considered in a future blog post. But before getting to that issue, a prior issue is whether this argument applies equally well to all types of incentives in all types of local areas. This will also be the subject of future blog posts.

Also, what about early childhood programs? Are their benefits also different from a national perspective than from a state or local perspective? And what do any such differences imply for federal policy towards early childhood programs?

To preview some of the conclusions, I conclude that early childhood programs’ benefits increase when viewed from a national perspective, compared to a state or local perspective. This contrasts sharply with business incentives. While federal policy should explore restraining some business incentives, early childhood programs should be encouraged by federal policy to expand and improve.

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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