Improving evaluation of economic development programs

The Pew Center on the States recently released a major study analyzing the strengths and weaknesses of what states are currently doing to assess their tax incentives for economic development. (I should disclose that I reviewed an advance copy of this report, and made some comments on that draft.)

As the Pew study reveals, many state governments do not do a good job of evaluating their business tax incentives for economic development. Some states do not have good measures of the resources devoted to these programs. Other states do not have good studies measuring how these tax incentives are distributed to different types of businesses. Finally, many states do not do a good of providing reasonable estimates of the effectiveness of business tax incentives in achieving their economic development goals.

On the other hand, there are states that provide good models of how to evaluating business tax incentives for economic development.  Certainly we should have a governmental budget accounting system that accounts for the true costs of these programs. We should also demand an information system that collects the needed data on how these programs’ tax benefits are distributed.

Although evaluation of effectiveness is difficult, it can be done.  As I pointed out in my book “Investing in Kids”, we know something about what types of businesses are most affected by business tax incentives. For example, we know that business tax incentives are far more effective when provided to businesses that are what regional economists call “export-base” businesses, which means businesses that sell their goods and services to customers outside the state.  For industries whose main customers are inside the state, total industrial activity will be driven by total state demand, not by business tax incentives. Tax incentives to such non-export-base businesses will largely be wasted.

We also know that business tax incentives are far more effective when targeted at high-wage businesses with strong local supplier networks. Regional econometric models can be used to assess the multiplier effects of such businesses.

We also have some reasonable estimates of the likely moderate responses of export-base businesses to the cost reductions brought about by business tax incentives.  Even without new econometric evidence on a state’s business tax incentives, this previous tax research literature can be used to evaluate effects.  I have done such simulation exercises in several previous papers, including one on incentives in general, and the other on Michigan’s MEGA program.

Finally, we know that any evaluation of business tax incentives must take account of the financing of such incentives.  Business tax incentives in almost all cases are likely to be a net fiscal cost for a state’s budget. This cost must be financed by increases in other taxes or cuts in spending. Such tax increases or spending cuts will almost certainly have negative economic effects, through effects on both demand for goods and services, and effects on the supply of labor and capital to the state economy.

If we had better evaluation of business tax incentives, and if this better evaluation led to needed program reforms, this would lead to the elimination of some inefficient business tax incentive programs. Such elimination of inefficient programs would free up resources that could be used for other purposes, including early childhood programs.

I don’t think advocates for early childhood programs, or other investments in skills development, should take the position that all business tax incentives are bad. This position is inconsistent with the evidence, and makes it more difficult to link up skills development programs with a positive message for stronger state economic development.

But I do think that advocates for early childhood programs, along with advocates for better and more efficient government, should be asking that all state government programs be rigorously evaluated, including tax incentives as well as early childhood programs. Those programs that show strong evidence of effectiveness should be expanded. Those programs that are ineffective should be reformed. In such a merit-based competition for public resources, I think it likely that early childhood programs would do well.

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.
This entry was posted in Business incentives, Economic development, Incentive design issues. Bookmark the permalink.