Weighing the costs: Making smart choices with business incentives

TML Communications Specialist

While incentives have become a major piece of the puzzle of economic development, sometimes incentive packages can do more harm than good when it comes to bringing business to the community.

Municipalities across Tennessee are looking for better ways to balance the pluses and pitfalls of tax incentives by making sure they get the biggest bang for their buck out of programs like tax-increment financing (TIFs) and payment-in-lieu-of-taxes (PILOT).

As a state, Tennessee already offers the fourth highest amount of incentives in the nation. The W.E. Upjohn Institute for Employment Research reported in 2017 that the state and local governments provide more than $2.5 billion worth of incentives annually, including property tax breaks, grants, and other subsidies.

That amount is nearly 1 percent of the state’s private-sector gross domestic product. The amount of incentives Tennessee offers is also 105 percent higher than the national average.
Companies claimed $90.5 million in jobs tax credits and $3.5 million in headquarters credits in fiscal 2017.

However, incentives have also brought major business to the state including IKEA, Amazon, Volkswagen, and Google — to name a few.
J. Thomas Trent, chairman of the Economic Development Practice Group and a member of the Real Estate team for Bradley Arant Boult Cummings, LLP, said the impact incentives can have and how companies choose where to locate have changed rapidly in the past decade.

“With the analytics available on the internet, software programs, and subscription services, site-selection consultants are now not site selectors but site eliminators,” Trent said. “Their job is to eliminate their site, and if you have gotten to the point that a site selector has called you, it means you’ve made it past the first several rounds. You won’t even know it if you have been eliminated before that.”

Additionally, Trent said recruiting business has gotten much more competitive even before incentives come into play.
“There are also many more states playing this game than there were 10 or 20 years ago. The competition is bigger,” he said. “TVA used to the main power company that was driving economic development, but now many utility companies are working on economic development. Some of the things that were advantages in our region are not as much of an advantage anymore.”

John Lawrence, manager of strategic economic development planning for the Memphis-Shelby County Economic Development Growth Engine (EDGE), said many site selection officials will not even consider areas that will not offer them some kind of incentive.

“The most recent survey of corporate relocation experts and professionals said once they identify the site, they want financial assistant,” Lawrence said. “At the top of the list, 86 percent consider tax incentives the most important.”

The role of incentives has changed in multiple ways. Matt Murray, director of the Howard Baker Center for Public Police and associate director of the Boyd Center for Business and Economic Research at the University of Tennessee, said that many communities do not realize how much they spend to bring a single job to their community.

Murray said in the 1980s and 1990s it wasn’t uncommon for an incentive package to cost $10,000 to $14,000 per job it brought to the community. Today, communities have doled out incentive packages that cost their communities anywhere between $100,000 and $1 million per single job it brings to the area.

The second-largest business tax break in Tennessee is the jobs tax credit, which cost the state an average of $52.1 million annually from 2011 to 2014. It gives companies a credit of $4,500 per job, with enhancements depending on how much a company invests in the state and where it locates.

Companies claiming the jobs tax credit created more than 41,000 new jobs from 2011 to 2014, and grew jobs at a faster rate than other companies that did not receive the credit, according to state economic development officials.

Often times, Murray said communities don’t do any type of cost-analysis to make sure the costs of providing incentives do not outweigh the benefit the community will receive. Additionally, he said many communities are misinformed about how much economic development an incentive is actually generating.

“A lot of people believe that the economic impact multiplier for their community is $8 or $10 for every $1 of incentives. That’s impossible,” he said. “Typically, it’s in the neighborhood of $2 or $3. For small communities, it’s often less than $2. That often means that $1 you spent is turning over less than one time. Incentives should provide a well-defined return on investment for public sector dollars, in other words taxpayer dollars.”

Trent said other considerations – such as having a ready site with utilities – are much more important to companies than incentives. However, incentives can still sweeten the pot.
“Speed is critical and having a site ready is critical,” he said. “You need to have an inventory of land. Incentives alone will not get you a deal. It used to be true, but it isn’t any more. However, they can help by lowering the cost of infrastructure. Once they have narrowed it down to a few sites incentives can make the difference. Once they’ve gotten to that site selection level, developers will also tell you that if you don’t put any incentives in, you’re no longer in the game. Incentives are a way to stay in the game.”
Lawrence agreed that the ability to deliver what a company is looking for in a timely manner can be a major determining factor in where a community wants to locate you.
“They don’t want hurdles; they don’t want multiple approvals,” he said. “They want timeliness , certainty, and a non-political environment. If you can’t provide those things, they will take you off the list before you even know you were competing. They want clear policies, simple applications, and a confidential process.”
However, Lawrence said what companies want from municipalities can clash with transparency demanded by taxpayers.
“The public expects businesses to benefit the community,” he said. “For every business official that thinks we aren’t doing enough there are thousands of taxpayers who think we are giving away the farm. They think that everyone else should love our town as much as we love our town, and therefore should do business with us. In reality, most of the businesses that are looking to site a location are doing this from a pure, cold bottom-line financial perspective. The public wants to know what we’re doing and how we’re doing it, which is only fair. But more often than not, we hear from the public that they don’t think we are holding businesses accountable and that long-term, these businesses are taking advantage of us.”
While incentives remain vital to recruiting business, not every community realizes the larger effect incentive packages can have on the community. Murray said caution is key when it comes to putting together incentive packages.

“It’s not whether you’re going to play the game or not; it’s the fact that you have to play the game. If you have to play the game, you should play it well and play to win,” Murray said. “It’s very hard to find economic evidence that economic incentives matter. Always keep in mind that we are the custodians of public sector funds that come from the taxpayers. Always exercise caution. It can be a really high price to pay for a single job. When you put a dollar into an economic incentive that is a dollar you could have put somewhere else in the community. That is a dollar for parks, public schools, or returned to taxpayers – all of which would have an impact on economic development.”
Community leaders should also keep in mind that economic incentive programs sometimes take decades to reap rewards.

“Incentives often don’t pay off until a 20 or 30 year window of time; That is a long period of time, and you have to question whether or not the company in question will still have a presence in your community in that period of time,” Murray said. “A lot of times, we don’t pay attention to the cost side of the incentive package. Public sector costs are a really important aspect and often aren’t included in analysis. If you are creating economic activity that is going to bring new people and new residents to your community that is going to put a lot of pressure on the public service delivery you already have in your community. The most important and most expensive public service is typically the local public schools.
Despite the risks, incentives can still bring rewards to an area. Trent said communities can use project and development agreements to bring additional benefits to the area as part of an incentive package.

“If you want them to hire local people or disadvantaged business enterprises, a certain number of employees, or want them to give money to schools you can do that,” he said. “You can cut the deal in any way you want as long as it’s legal and not discriminatory.”

Incentives are also often a requirement if a municipality wants state support on development associated with a project.
“Often state programs look for contribution from the community, especially if you are looking for grants,” Trent said. “TIF and PILOT programs can help you leverage those costs if you are looking for grants.”

Murray said successful incentives accomplish several things:

Provide an efficient, well-defined return on investment;
Are transparent so that benefits and costs are clear to taxpayers;
Provide certainty on the magnitude and timing of tax relief as well as the realization of tax losses that impact public budgets;
Do not have retroactive policy changes;
Are easy and simple to administer and comply with;
Are targeted and provided on a discretionary basis only for economic activity that won’t otherwise take place;
Minimize fiscal exposure of public funds through financial caps or time limits;
Have a leveraging effect, drawing on additional resources from the public and private sector
Are held accountable through performance-based criteria;
Have built-in evaluation framework to determine if incentives introduced new economic activity or rewarded economic activity that was already existing; and
Are controlled by a public sector agency that ensures proper administration and evaluation.

Murray said communities should also make sure the projects they incentivize do not cannibalize existing industry or leave the community worse off than it was before the company located to the area.
“Only focus on industries that export goods or services from your community; you don’t want to finance economic activity is that is competition with other economic activity in your area,” he said. “You want to bring in new purchasing power, new income, and new jobs that will ripple across your community.”
For Memphis and many other larger cities, PILOT programs are more common than TIFs. Lawrence said that it can be hard to both satisfy businesses and taxpayers when incentives come into play.
“Many of us in the economic development industry are under constant pressure,” Lawrence said. “It seems no one is ever happy. You aren’t doing enough for business; the taxpayers feel you’re giving away the farm. For us, the PILOT program is our lightning rod. Memphis is a community that doesn’t do a lot of TIFs. We have a handful of TIF districts, but we rely heavily on PILOT programs.”
Lawrence said the city launched its first ever PILOT guidelines six years ago and adopted its most recent revision to those guidelines in March.
“Our policies have been painstakingly crafted so our community and the state of Tennessee are in the best position to attract and retain businesses while still maintaining the trust the public has put in us for our tax dollars,” Lawrence said. “In that six-year period, we have approved 74 PILOTs, creating 18,000 jobs with an average wage of $71,000. We have tracked $3.5 billion in capital investment, which has resulted in more than $1 billion in new tax revenue and $460 million in spending with minority businesses. We have done this while capping every project’s benefit at 25 percent. This ensures there is an immediate return of 25 percent. We capped the term at a maximum of 15 years without our city council’s approval.”
Enforcing this compliance and molding the program to the Memphis-area’s specific needs has ensured incentives bring back more money to the community and that incentive packages are as transparent as possible for taxpayers, Lawrence said.
There is one thing, however, Lawrence said EDGE has no plans to do in the future.
“We are resistant and continue to be resistant to additional layers of approval that could slow and politicize the process,” he said. “We feel that would diminish economic activity.”
To make sure they are getting the most out of incentive packages, Murray said cities should do cost analysis both before the package is finalized and afterwards to make sure what was promised is delivered.
“That allows you the opportunity to eliminate incentives that are not effective, redesign an incentive to make it more effective, or simply retain the incentive and keep that model for use in the future,” he said. “Be aware that the data demands to do this type of analysis are rather mind-boggling, but it doesn’t mean you shouldn’t do it. The methods used are very pivotal in affecting the findings.”
In order to keep the public informed about incentives without betraying the trust of businesses looking to locate in the area, Lawrence said Memphis ensures board meetings are public and that expectations and evaluations of businesses receiving incentives are posted online where the public can access them. A third party also analyzes projects to help show the benefits the incentives are bringing in to the company.
“Once we receive an application, that document is posted publicly on our website,” he said. “Once we receive a cost-analysis, that document is posted on our website. Once we receive a terms document, that is posted on our website. These are also sent to the media and anyone else on our email list. This all occurs before the board meets so it can be reviewed before the board approves a project. We require all PILOT recipients to submit annual reports and have on-site inspections. In-depth audits are done once every four years. For companies that don’t meet their targets, we either call back the incentive or eliminate it completely. We always do it very quietly, and we don’t enjoy doing it.”
For Murray, the best investment a community can make is in its human capital, providing education for its workforce that can both attract new business as well as still have marketable skills if businesses leave the area.
“Focus on investment in human capital,” Murray said. “That way, if the company leaves the community you still have skilled workers that you can market as an asset. Recruit companies that are competitive in a regional or global sense, which bring in new ideas and new practices. Invest in infrastructure like roads, industrial parks, and so on. That is an investment in the future that provides returns.”