Tax credits have been the incentives workhorse for economic development organizations, but we see this changing. Our research indicates that today’s most competitive incentive offerings combine workforce training, infrastructure and site investments, specialized services, and traditional tax abatements from united state and local partners.
Tax credits have become problematic for several reasons:
- Tax credits are often presented as no-cost incentives. That is, tax credits are not taken (incentives “paid out”) until the company has met certain thresholds and has started paying the taxes against which the credit is taken. However, as this article in the Wall Street Journal points out, the fiscal costs are substantial. It is not clear to us that other taxes expected to be generated by incentivized projects either materialize or are sufficient to fill the budget gap.
- One reason might be that tax credits are more important to existing businesses than firms new to a location, based on our review of major incentive deals, so an incentivized project may not generate as much new tax revenue as anticipated.
- Once the tax credits have been granted, states do not know when businesses will choose to take the credit, wreaking havoc on state budgets, possibly for decades depending on the terms of the tax credit arrangement.
- Some tax credits are refundable (paid back to the company if their tax liability is not high enough to take the credit) or transferrable (sold to another taxpaying entity). Film tax breaks often fall into this category, lowering the taxes paid by other taxpayers that are not the direct target of the incentive.
Using tax credits in this manner is not sustainable. To the extent economic development organizations continue to use tax credits, caps and limits will become the norm.
Instead, we see successful economic development organizations packaging multiple state and local incentives into tailored offers recognizing the unique needs of each business that may still use some tax credits but also combine:
- Job training
- Traditional property and sales tax abatements or exemptions
- Infrastructure investments
- Site and building development
- Fee waivers
- Specialized services, especially for innovation oriented firms and entrepreneurs