Should investments in machinery and equipment continue to be incentivized? Most states offer a variety of economic development incentives designed to reduce the costs associated with machinery and equipment purchases in order to encourage new investment. Federal tax policy also has several provisions, such as accelerated depreciation, to do the same.

Not all researchers agree that this is good policy.

  • The February 2019 NBER Working Paper, “Tax Policy and Local Labor Market Behavior,” analyzes the effect of accelerated depreciation policies on employment and earnings. Researchers found that the policies did stimulate investment, but that the investment did not lead to sustained job creation or wage growth. Further, the policies imply a long-term substitution of capital for labor – or replacing workers with machines. If the intent of incentivizing investment is ultimately to help workers, the authors suggest that this type of tax policy is not effective.
  • MIT economists also question whether incentivizing investment in automation and other technologies that reduce demand for labor produces enough benefits to merit the subsidy. A recent New York Times article summarizes their argument that incentives to subsidize capital investment encourage businesses to use capital when they otherwise would not, replacing workers with machines even when it is not beneficial. This has two negative effects. One, government misses out on substantial revenue associated with payroll taxes and other individual taxes. Second, subsidies may encourage over-investment even when there are no productivity gains, so while the business wins financially, the economy loses.

Most state and local governments offer many incentives to encourage capital investment. A study conducted for Smart Incentives found state-level manufacturing incentives are tilted in favor of capital formation relative to those designed to increase jobs or improve wages. Common incentives include accelerated depreciation, sales and use tax exemptions, property tax abatements, and utility incentives to reduce costs for energy-intensive operations. However, a review of recent research into initiatives designed to encourage manufacturing in the journal Economic Development Quarterly noted, “direct assistance to firms in the form of management advice, technical support, training or skills upgrades, and design support may be valuable as policy makers seek alternative solutions to promoting manufacturing other than controversial tax or cash incentive programs.”

There is no sign that policymakers are shying away from investment incentives for manufacturers, even while expanding other programs and services designed to support them. Nevertheless, economic developers may find that they need to review their manufacturing incentives to make sure that they remain current in meeting the needs of today’s manufacturers and are aligned with expected economic and fiscal outcomes.

 

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