A just-posted working paper, by my colleague Kevin Hollenbeck and me, examined the state of Washington’s business tax credit for R&D spending.  Our conclusion is that this tax credit is quite costly per job created.  The cost per job-year created (a job-year is one job created for one year) is at least $40,000 to $50,000.

This is quite costly per job-year created because the local economic development benefits of jobs created through business tax incentives are likely to only be a small fraction of the earnings associated with those jobs. As I have argued since my 1991 book, Who Benefits from State and Local Economic Development Policies?, only a fraction of the jobs brought to a state economy through economic development incentives go to local residents. For every 5 jobs created, only 1 results in higher employment rates – the rest go to in-migrants. So even if the created jobs pay over $50,000, the benefits for state residents of the new jobs will be considerably less than $50,000.

Why is this particular business jobs tax credit so costly? First, the business tax credit is not targeted at what regional economists call “export-base” industries. By “export-base” industries, regional economists mean industries that sell their goods and services to customers from outside the region.

State and local business tax credits that go to locally-oriented businesses are less likely to generate net local jobs. Even if the tax credit helps create jobs in assisted businesses, these businesses will increase their market share with the consequence of reducing the market share of other locally-oriented businesses. As one example, if we subsidize McDonald’s to expand, even if this subsidy is successful in inducing such an expansion, this expansion reduces sales and hence jobs at Burger King.

For Washington’s R&D tax credit, only 40% of the potential job creation due to the credit is in export-base industries. The 60% that goes to locally-oriented, non-export-base firms does not do much for the state’s economic development.

Second, this particular tax credit provides no incentive for expansion for about 30% of the Washington firms that received credits. This is because the credit was not refundable, and these firms reduced their taxes to zero before fully utilizing their R&D credit.  As a result, these firms would not increase their credits received by expanding their R&D activities. This lack of an incentive for expanding R&D activities reduces the job-creation effects of the credit.

Targeted business tax credits can sometimes be effective in job creation. But such success requires attention to the details of credit design.  Credits should be targeted at export-base firms, and provide a meaningful incentive for expansion to all assisted firms. Finally, credits will have larger net effects on a state economy if they are in firms that have high multiplier effects, which are likely to be firms with strong links to local suppliers, and which pay high wages.