Solving The Problems of Economic Development Incentives: Erspective

Growth and Change
Vol. 36 No. 2 (Spring 2005), pp. 139-166
PERSPECTIVE
Solving the Problems of Economic
Development Incentives
TIMOTHY J. BARTIK
ABSTRACT This paper reviews the research literature relevant to economic development
incentives provided by state and local governments, and recommends reforms in these incentives.
I argue that the main problem with current incentive policies is that state and local governments
often provide incentives that are not in the best interest of that state or local area, for example that
are excessively costly per job created, or that provide jobs that do not improve the job opportu-
nities of local residents. I suggest that reforms should be “bottom-up” rather than “top-down.”
Regulation of incentives by the federal government may prevent both desirable and undesirable
incentives. “Bottom-up” reforms would include more information on incentive offers, a budget
constraint on the volume of incentives, stronger standards for job quality and job accessibility for
the local unemployed, and better benefit-cost analyses of incentives.
ow can economic development incentives best be reined in? I agree with most stu-
H dents of this issue that economic development incentives are often wasteful. But
this paper maintains my position that some incentives are socially beneficial.1 The chal-
lenge is to design reforms that encourage wasteful incentives to be dropped, and socially
beneficial incentives to be kept.
To design incentive reforms, we must first agree on the causes of current U.S. incentive
practices. This is the focus of the paper’s next section. What are the social benefits and costs
Timothy J. Bartik is senior economist at the W.E. Upjohn Institute for Employment Research, a
non-profit and non-partisan research organization in Kalamazoo, Michigan. His e-mail address is
[email protected]. A previous version of this paper was presented at the conference, “Reining in the
Competition for Capital” (February 2004) at the Hubert H. Humphrey Institute, University of
Minnesoat, and at the Twelfth Annual Funding State Services Conference (November 2004) of the
Center for Budget and Policy Priorities. I thank Ann Markusen of the Humphrey Institute and Michael
Mazerov of CBPP for the opportunity to address these issues before informed and interested audi-
ences. I appreciate helpful comments on this paper from conference participants, as well as Eric
Thompson of this journal, and George Erickcek of the Upjohn Institute. I also appreciate the assis-
tance of Claire Black, Linda Richer, and Babette Schmitt with this paper. This paper reflects the views
of the author, and should not be construed as official views of the Upjohn Institute, the University of
Minnesota, or the Center for Budget and Policy Priorities.
Submitted June 2004; revised Dec. 2004

© 2005 Blackwell Publishing, 350 Main Street, Malden MA 02148 US and 9600
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140 GROWTH AND CHANGE, SPRING 2005
of incentives? Why are incentives so often wasteful? Answering these questions allows us to
address the problems leading to wasteful incentives, while encouraging beneficial incentives.
My conclusion is that some incentives are beneficial for two reasons: First, because
corporations are becoming more footloose, they are becoming more responsive to incen-
tives, and second, increased local employment rates yield social benefits. However, incen-
tives are often wasteful for two reasons: local policymakers often overestimate the benefits
of incentives, and the local debate over incentives is dominated by business interests.
Unlike some students of this issue, I do not think that incentives are excessive because a
state government ignores an incentive’s “spillover costs” for other states.
Based on this analysis, I conclude that incentive reform should focus on improving
the local decision-making process for incentives. Local decisions about incentives will
be improved by a more democratic process with full information, a budget constraint on
incentives, better benefit–cost analysis, incentive designs that target new business activ-
ity that brings social benefits, and performance requirements. Federal policy can encour-
age better information about incentives, help finance efficient incentives in economically
distressed regions, and encourage cooperative economic development policy in metropol-
itan areas that cross state lines.
The Forces Leading to Incentives

Before discussing the forces leading to incentives, I should define what I mean by
incentives. In this paper, I focus on the type of incentive that looks most like legalized
bribery of the rich: cash or near-cash assistance provided on a discretionary basis to attract
or retain business operations owned by large businesses. Such cash or near-cash assis-
tance includes property tax abatements, discretionary credits under the state’s corporate
income tax, low-interest financing, and free land or buildings. This type of incentive
deserves the most attention because, out of the total resources for economic development,
such incentives comprise the largest share. For example, in Michigan such incentives are
about three-quarters of all resources devoted to economic development programs (Bartik,
Erickcek, and Eisinger 2003).2
Other incentives to large businesses are close substitutes for cash assistance. Incen-
tives to attract or retain large businesses may also include customized services, which help
meet the needs of an individual business, such as information on potential sites, help with
state or local regulations, customized training for new or existing employees, and expe-
dited provision of site-related public infrastructure, such as access roads. Customized ser-
vices are sometimes almost equivalent to cash; for example, in some cases “customized
training” is writing a check to the company to train its own employees. Another close sub-
stitute for discretionary cash incentives are business tax breaks provided as an “entitle-
ment” under state or local tax laws, such as investment or employment expansion tax
credits that go by right to all businesses that meet the tax law’s criteria. Discretionary tax
incentives, such as property tax abatements, may become so routine that they are almost
equivalent to “entitlement” tax breaks. Reforms to cash incentives for large businesses
may lead to increased use of these other incentives.
PROBLEMS OF ECONOMIC DEVELOPMENT INCENTIVES 141
Economic development programs also provide assistance to new businesses and small
and medium-sized businesses, including many high-tech businesses, which is intended to
be an “incentive” for the growth of such businesses. Assistance to small and medium-
sized businesses includes cash assistance, such as loans or equity finance, and grants for
research and development. Assistance to small and medium-sized businesses may also
include customized services, such as information on how to start up a business, or make
an existing one more profitable (e.g., industrial extension services, small business devel-
opment centers). Reforms to incentive programs for large businesses may also affect these
other programs.
Is there a good rationale for state and local governments to offer economic develop-
ment incentives to attract or retain large businesses? Is there a good rationale for why
such incentive use appears to be rising over time? One plausible rationale is that incen-
tives are increasingly perceived as a necessary cost incurred to produce social benefits. It
seems increasingly plausible that incentives might help attract or retain business, and
thereby produce benefits such as greater employment rates and a stronger state and local
fiscal situation. I will argue that these statements are true, but that incentives’ costs are
often large while incentives’ benefits are often modest.
Incentives may increasingly affect business location decisions because businesses are
increasingly footloose. As shown in Figure 1, over the past 100 years, transport and com-
munication costs have declined. Cheaper transport of inputs and outputs, and the greater
ease of using communications and computers to coordinate business activities at distant
locations, allows business activities to be sited at a wider variety of locations. Because
businesses have many more sites that are acceptable options from a transport and com-
100
90
80
70
Relative cost index
60
50
40
30 Sea freight
20 Air transport
Telephone call
10 Computers
0
1910 1920 1930 1940 1950 1960 1970 1980 1990
NOTE: These data are derived from United Nations Development Program (1999, p. 30). This particular graphical
presentation was developed by Rodrigue (2004). The figure sets transport and communication costs equal to 100 for the
first year for which such cost data are available in the UN report. Each type of cost therefore uses a different base period.
This allows all the data to be placed on one graph.
FIGURE 1. RELATIVE TRANSPORTATION AND COMMUNICATION COSTS.

munications perspective, businesses are much more sensitive to local costs, such as wages
and taxes. Wages are a larger share of costs than taxes, but taxes and the incentives that
offset them are more immediately controllable by government.
Declining transport and communication costs help explain why research increasingly
shows a statistically significant but modest effect of state and local tax rates on economic
development. Reviews of the literature suggest that the long-run elasticity of a state or
metropolitan area’s business activity with respect to state and local taxes is between -0.2
and -0.3 (Bartik 1991a, 1992; Wasylenko 1997), which means that a 10 percent reduction
in effective state and local business tax rates (for example, a reduction of the state corpo-
rate income tax rate from 5.0 to 4.5 percent, accompanied by similar reductions in other
state and local business taxes), with state and local public services held constant, will
increase the long-run level of local business activity by 2 or 3 percent.3
Such an effect on business activity is not huge. If the state and local tax cuts are
financed by cutting public services, the result may be lower business activity. The elas-
ticities are not large enough to produce a Laffer Curve, in which cuts in tax rates would
raise the tax base enough to increase revenue. The estimates imply that the gross cost of
creating a job through lower business tax rates is a sacrifice of $10,000 annually per job
in lower business tax revenue. The higher business tax base would offset only about a
quarter of this “static” revenue loss, resulting in a net cost of creating a job through lower
business tax rates of about $7,000 per year in foregone business tax revenue. At a 10
percent real discount rate, the present value cost in foregone business tax revenue is
$70,000 per job created.4 Still, for state or local officials searching for some way to affect
the local economy, lowering taxes seems one of the few options.
These figures are for business tax cuts for an entire state or metropolitan area. Research
suggests that a business tax cut by an individual suburb within a metropolitan area, holding
the taxes of other jurisdictions constant, has much larger effects, perhaps 10 times as great
per dollar of incentive. That is, a 10 percent cut in an individual suburb’s business taxes,
such as a cut in the business property tax rate from 2 percent to 1.8 percent, will increase
that individual suburb’s business activity by 20 percent, largely by capturing business activ-
ity from other jurisdictions in the same metropolitan area. These larger effects make sense
because individual jurisdictions within a metropolitan area are closer substitutes for one
another than different states are for one another, as jurisdictions within the same metro-
politan area offer more similar access to markets and inputs. The research is mixed on
whether business tax cuts for large central cities have significant effects on business loca-
tion (Bartik 1991a, 1992; Haughwout et al. 2003).
What implications do these estimated effects of state and local business tax cuts have
for the effects of incentives? Few studies directly estimate the effects of incentives.
However, under the assumption that a “dollar is a dollar,” tax incentives for a large business
should have similar effects on its location decisions to an equal dollar-sized business tax
cut. Therefore, the effects of incentives on the probability of a particular branch plant locat-
ing in a state should, on average, be such as to yield the same expected gross dollar cost per
job as business tax cuts. For example, the highest incentive offers, according to Fisher and
Peters (2002), are equivalent to an annual subsidy of about $2,800 per worker inside some
enterprise zones.5 To be consistent with the business location literature, reducing business
taxes via an incentive offer of $2,800 per job for a branch plant, compared to no incentive
offer, would increase the probability of a new branch plant choosing the state by about 0.3.6
This implies that for every 10 plants offered such an incentive, the incentive would be deci-
sive for about 3 of them. The incentives given to the other 7 plants would have no effects
on business location or employment growth. The only effect would be an extra cost to state
and local governments of these unneeded 7 incentives. Unless economic developers can
somehow determine which of the 10 plants “needs” the incentive to tip its location decision,
this loss on 7 of the 10 plants is a necessary cost to tip the location decision of the other
3 plants. For smaller, more “normal” incentives, an even lower percentage of location
decisions would be tipped by incentives. Fisher and Peters’ figures imply that the mean
state/local economic development incentive outside of enterprise zones is equivalent to an
annual subsidy of about $300 per worker. Such an incentive would be expected to affect
the location decision of only 3 out of 100 subsidized companies.7
The benefits of greater job growth in a metropolitan area occur in the form of earnings
increases for local residents who get jobs as the local employment rate increases, earnings
increases for local residents who move up to better-paying jobs with a tighter local labor
market, local property value increases, profit increases in local businesses that have a head
start in serving a larger local market, and tax base increases for state and local govern-
ments.8 These benefits must be netted against costs of greater local job growth, including
the value of the foregone nonwork time for local residents who gain jobs, the costs of addi-
tional public services required by expanding employment and population, and environ-
mental costs.
We have reasonable estimates of the magnitude of these benefits and costs and how
they are affected by differences in local conditions and the type of job growth (Bartik
1991a, 1993). A 1 percent increase in local employment is associated in the long run
(more than five years) with an increase of 0.8 percent in local population, implying that 8
out of 10 new jobs in a metropolitan area go to persons who otherwise would have lived
elsewhere. This 1 percent job increase is also associated with a 0.2 percent increase in
the local employment rate (employment to population ratio), as local residents increase
their labor force participation as they acquire better job skills with their greater job expe-
rience. One percent extra job growth in the long run is associated with average real wages
moving up by 0.1 to 0.2 percent, but due entirely to local residents moving up to better-
paying occupations; the real wages of particular occupations are unchanged, with occu-
pational wages just matching increases in local prices. At low unemployment rates, when
jobs are easy to get, the value of time spent unemployed, which economists call the reser-
vation wage, may be 90 percent of the market wages, which would imply a cost of fore-
gone nonwork time of 0.18 percent in a low unemployment labor market due to 1 percent
extra job growth.
The required public services due to growth should, in the long run, increase about the
same as the tax base for employment growth that is accompanied by the same population
growth and involves no occupational upgrading. But as detailed above, the employment
growth due to the “labor demand” shock caused by economic development policies will
raise employment rates and increase real wages due to occupational upgrading. If employ-
ment rates go up, tax revenues should increase faster than public spending needs for three
reasons: First, business growth by itself brings tax revenue greater than public services,
estimated as $1.70 in taxes per dollar of required public services according to one source
(Oakland and Testa 1996); second, increased employment rates should reduce required
state spending for transfers, reducing welfare spending by about 6 percent for a 1 percent
increase in employment growth (Bartik and Eberts 1999), and unemployment benefit
outlays by about 3 percent (Bartik 1991b); third, increased employment rates will raise per-
sonal tax revenues per capita, by a percent equal to the percent increase in the employment
rate. Increases in real wages, such as those caused by the occupational upgrading due to
increased labor demand, will also raise personal tax revenues, which should go up approx-
imately proportionately with the increased real wages. In the short run, public service costs
associated with growth will go up less than the percentage increase in employment and pop-
ulation if there is excess capacity in local infrastructure. On the other hand, if new infra-
structure is required, and the depreciation cost of the current infrastructure is not reflected
in local budgets, then most estimates suggest that additional public service costs will sig-
nificantly exceed new tax revenues in the short-run (Altshuler and Gomez-Ibanez 1993).
One percent extra employment growth will increase local property values by 0.4
percent. However, the present value of the increased earnings from growth are at least
triple the size of the property value gains (Bartik 1991a, 1994b). In addition to increases
in property values due to increased land demand, the value of “brownfield” property that
is cleaned up as part of an economic development project may also go up due to remov-
ing this development barrier. Other local asset values will also change: locally owned
businesses that have some comparative advantage in selling to a local market will increase
their profits, whereas locally owned businesses that sell to an external market may lose
profits due to increased wages and rents.
Other than brownfield clean-up, most environmental effects of growth are likely to be
negative, but will vary greatly with project details. In addition, changes in community
character that accompany growth may be viewed negatively by the original local residents.
The net effects of greater job growth are likely to be progressive, as lower-income
groups are more likely to be initially nonemployed or employed in low-wage jobs. There-
fore, most estimates suggest that the lowest income quintile probably has earnings gains
that are three or four times greater, in percentage times, than the earnings gains of the
average family, and income gains that are around twice as great, in percentage terms, as
the real income gains of the average family (Bartik 1994b). However, the actual dollar
effects on earnings and income of the lowest income quintile are less than that of the
average family, as many low-income individuals are disconnected from the labor market
(Bartik 2001, Table 5.3). The progressivity of increased job growth is considerably less
than the progressivity of redistributive social programs, which deliver their greatest dollar
benefits to the lowest income quintile (Bartik 1994b).
The bottom line from this analysis is that for an average incentive project in a low
unemployment local labor market, benefits and costs are of similar magnitude (Bartik
1991a, p. 183). The paper’s appendix and its accompanying table presents some illustra-
tive calculations. There is sufficient uncertainty about the estimated effects of taxes on
growth, and growth on local economic variables, that whether the net benefits are positive
or negative is unclear. Benefits and costs will vary greatly with project particulars.
Social benefits of incentives are greater if the project overcomes “market failures” that
impede the use of local resources.9 For example, social benefits are greater if the project
helps overcome involuntary unemployment or underemployment that impedes workers
from being employed or being employed in higher wage jobs. Social benefits will be
greater if local employment rates increase more, or local residents move up to higher-
paying jobs to a greater extent, or if the local labor market is more depressed. An increas-
ing local employment rate provides more earnings benefits to local residents, reduces the
need for social services to the nonemployed, and reduces the public services costs and
environmental costs associated with increased population. An increase in higher-paying
jobs for local residents increases earnings benefits, and increases fiscal benefits by reduced
social services and increased taxes. In a more depressed local labor market, the non-
employed will be more desperate for jobs and have lower reservation wages.
Social benefits will also be greater if the current public infrastructure is underutilized,
which allows increased employment and population growth to increase tax revenue without
a commensurate increase in public infrastructure costs. This is more likely in a local area
that has been sufficiently economically distressed that it has lost population and employ-
ment from some previous peak. Social benefits will also be greater if the project over-
comes regulatory and other barriers that prevent brownfields from being productively used.
But policymakers should also be aware that social benefits of growth will be much
reduced under any of the following circumstances: low-unemployment local labor markets;
lower wages of the new jobs; fewer local workers for the new jobs; significant public infra-
structure or environmental costs. For example, estimates suggest that if the job growth is in
industries that pay 10 or 15 percent less than the average industry controlling for worker
characteristics, then the job growth may produce no earnings benefits for local residents
(Bartik 2004b). If there are zero earnings benefits from additional employment growth, and
consequently little if any fiscal benefits, it is highly unlikely that an incentive package will
pass a benefit-cost test unless it has extremely low costs per job created.
Therefore, incentives can affect business location, and increased job growth can yield
important social benefits. We would expect informed state governments, or metropolitan
agencies concerned with economic development, that are maximizing the well-being
of all their residents, to only offer incentives if the benefits outweigh the costs. These
calculations would consider that only a fraction of incentive offers would prove decisive,
and only a fraction of newly created jobs would go to local residents. Policymakers
would consider the circumstances of the local economy, the environmental costs or
benefits, the quality of the new jobs, and who is hired for those new jobs. So, what is the
problem?
The problem is that many incentives currently being offered in the United States have
costs that exceed benefits. For example, in 2001 Chicago awarded large incentives to the
Boeing Corporation for relocating its headquarters, even though the jobs would go to relo-
cated workers, which eliminates many of the labor market benefits.
One cause of wasteful incentives is ignorance. Policymakers assume that all growth is
good. Policymakers assume that all incentive offers are decisive. It is often assumed that
benefits can be measured by looking at the earnings and tax base associated with the new
business activity. This assumption forgets that only a portion of the new jobs go to local
residents and the unemployed, and that new public expenditures will be required.
But there may be reasons for ignorance. As Upton Sinclair said, “It is difficult to get
a man to understand something when his salary depends upon his not understanding it.”10
Local economic development decisions have been dominated by local business interests,
including Chambers of Commerce, newspapers, banks, and real estate developers. From
these groups’ perspectives, the benefits of economic development are the increase in the
value of their property, including the value of local business assets, and this increase in
local capital values is closely related to the earnings and tax base increase of the new plant.
Furthermore, the costs of the incentives, including the incentives that do not work, will be
borne largely by the general public. There is truth to the observation by John Logan and
Harvey Molotch that “For those who count, the city is a growth machine, one that can
increase aggregate rents and trap related wealth for those in the right position to benefit”
(Logan and Molotch 1987, pp. 50-51).
Unlike some analysts of incentives, I don’t think the fundamental problem is that a state
government (or a metropolitan-wide economic development authority) fails to take into
account the negative effects of its incentives on other states. If all states had rational
incentive regimes, on the margin investors in each state would be charged a tax rate net
of incentives that would reflect the marginal public service and environmental costs, net
of any employment benefits, that the investment caused. Under those conditions, a state’s
incentive that attracts a marginal plant that would have otherwise gone to another state
causes no net cost for that other state. Of course, states don’t usually have rational incen-
tive regimes, and so it is likely that attracting this marginal plant would cause net social
costs (or benefits, depending upon the net effect in the other state) for the state that other-
wise would have received this investment. But this “externality” is not the fundamental
problem, rather it reflects the fundamental problem: each state lacks, from its own self-
interested perspective, a rational incentive regime that maximizes the interests of all state
residents.
Critics who argue that incentives negatively affect other states also argue that states are
offering incentives so excessive that the social costs of attracting these new plants exceed
the social benefits. If this is the case for all states, then if state X attracts a plant that
would have gone to state Y, state X is doing state Y a favor by saving it from a wasteful
incentive.
This analysis so far has considered economic development decisions by a state or an
entire metropolitan area, and asks whether a state or metropolitan area acting rationally
has the proper incentive to consider all benefits and costs. The analysis is different when
we consider economic development decisions for an individual suburban jurisdiction. For
an individual suburban jurisdiction attracting a new plant, the main effects on the juris-
diction itself are effects on the jurisdiction’s tax base and the jurisdiction’s environmental
quality. The net fiscal costs of providing public services to additional households attracted
by the new business activity will mostly be incurred by other jurisdictions in the metro-
politan area, or by the state government, as most workers in an individual suburban juris-
diction do not live there. The employment benefits of increased employment rates and
promotions to better-paying occupations will also mostly be received by residents of other
jurisdictions. The decisions of individual suburban jurisdictions about incentives have no
strong reason to fully reflect all these social costs and benefits.
Alternative Incentive Reforms

Given this economic context, what incentive reforms are desirable? In this section, I
evaluate the merits of possible reforms. Although some reforms are mutually exclusive,
others could be combined.
Maintain Traditional State and Local Policies towards Business, but Remain Com-
petitive in the Global Economy. State and local governments would maintain their tra-
ditional business tax systems and not offer any incentives or other business cost reductions
to improve the local business climate. As mentioned previously, this traditional system
imposed state and local taxes on business that exceeded the public services to business,
with $1.70 in business taxes per dollar of public services to business (Oakland and Testa,
1996).
For most state and local areas, I doubt whether this alternative will prove politically
viable. The mobility of business is increasing. Most state and local areas will sometimes
experience high unemployment that will lead to public demands for action, and this high
unemployment will also increase the benefits of growth. There is enough evidence that
business taxes and incentives affect local growth that business interests will be able to
argue for reduced taxes or increased incentives to reduce unemployment. The argument
for doing something will win out over the argument for doing nothing.
Localism. Rather than competing for mobile capital, local areas could “just say
no,” eliminate incentives for mobile corporations, and rely on locally generated capital.
The best articulation of this approach is in Michael Shuman’s (2002) book, Going Local,
although this approach appeals to many American community activists. Shuman
advocates community corporations with voting shares controlled by local residents,
with these community corporations making the local economy more self-sufficient by
producing goods and services that replace imports of goods and services from other local
areas.
The main problem with this approach is that greater reliance on local capital and local
production would significantly reduce an area’s real per capita income. There are static
and dynamic gains from trade and capital mobility. Local areas should be free to pursue
this option, but local residents should understand the costs.
Develop Unique Local Assets that Yield Economic Rents. Local areas can develop
unique assets that make their area significantly more valuable to large businesses than these
businesses’ next best alternative, so that these large businesses receive what economists
call an “economic rent” from the local area. This “economic rent” would allow business
taxation in excess of public service costs without offering incentives to attract or retain
these large businesses. One unique local asset would be a unique cluster of industries that
increases productivity by resulting in more new ideas, and greater availability of special-
ized inputs such as workers with special skills (Rosenfeld 2002a, b). Another unique local
asset would be distinctive local amenities that attract what Florida (2002) calls the “cre-
ative class,” the professional and technical workers who enhance productivity for many
high-tech businesses.
The problem is that for most local areas, it is difficult to develop unique industry clusters
or local amenities. Businesses will have many options of similar metropolitan areas that
offer advantages from industry clusters and local amenities. There are then no economic
rents for local areas to exploit, and offering incentives must at least be seriously considered.
Lower Overall Business Tax Rates. Faced with businesses with many location
options, localities can respond by lowering overall business tax rates rather than offering
special incentives. This low tax alternative to incentives is favored by many conservative
critics of incentives.
The problem is that this change would significantly reduce tax revenue, forcing diffi-
cult choices on state and local governments about raising household taxes, or cutting public
services or transfers. These problems would be particularly acute in economically dis-
tressed local areas.
Lower Marginal Tax Rates on New Business Operations. Rather than cutting busi-
ness tax rates across the board, state and local areas could give tax credits or deductions
for business investment or employment expansion. Compared to overall business tax
reductions, this results in less of a short-run or medium-run revenue loss. Reductions in
taxes on new business operations are similar to incentives, but would be provided as an
entitlement to all businesses meeting the law’s criteria, rather than in a discretionary
manner to approved businesses.
Providing tax breaks as an entitlement, rather than at discretion, in theory encourages
a state or local government to analyze the impact of the tax break in toto. In practice, such
tax breaks are not reviewed closely. In addition, entitlement tax breaks, compared to dis-
cretionary tax breaks, do not allow the advantages of being selective, such as selecting
projects in which assistance is more likely to tip the location decision, or the location has
greater benefits.
Make Discretionary Incentives Truly Selective. As mentioned before, many discre-
tionary incentives are provided so automatically to projects that they become equivalent
to a tax break provided as an entitlement. Economic developers can be forced to become
selective by requiring the number of incentives be capped, or better, that the dollar volume
of incentives be capped. Criteria can be required for selecting incentive winners from
incentive applicants, such as evidence that this incentive will tip the location decision, and
benefit–cost analyses of the projects. Michigan’s “MEGA” program, for example, which
provides large tax credits to attract or retain businesses, has limits on the annual number
of projects. It requires that all projects present data showing that a non-Michigan site
would be more profitable without the incentive, and that all projects be subject to fiscal
impact analysis.11
Capping incentive volume limits incentive costs. Political debate on the incentive cap
may lead to a broader debate about the incentive regime. Whether government officials
can determine if the incentive is needed to tip the location decision is more questionable.
However, requiring businesses to legally certify, with official financial figures, that without
the incentive the business would have located elsewhere, might discourage some egregious
cases where clearly the incentive was irrelevant to the location decision. Finally, models
can be developed to provide reasonably accurate estimates of the labor market and fiscal
benefits of a new facility.
Transparency. The details of incentives and incentive offers can be required to be
clearly publicly disclosed. This disclosure promotes broader public debate. If the incen-
tive offers are reported in a consistent fashion nationally, the disclosure may also give eco-
nomic developers a more accurate knowledge of what alternatives are open to business
location decision makers, which should improve the bargaining position of economic
developers. Businesses already know what they have been offered by different local
areas, but economic developers do not. The national collection of this information would
allow better research on incentives. Finally, transparency is essential for any incentive
regulation by the federal government, or supranational organizations. The European Union
requires public disclosure of incentives by its member states, and disclosure and trans-
parency are encouraged by international trade agreements.
Metrowide Economic Development Programs, not Within-metro Competition. State
governments can require that incentives not be provided by individual local governments,
but only by the state as a whole or by metrowide organizations or coalitions. As discussed
previously, local governments that are a small part of the local labor market will not con-
sider many important social effects of business growth when offering incentives, such as
the labor market benefits throughout the metropolitan area, and the fiscal effects of
increased metropolitan population. This makes it unlikely that incentive policies con-
ducted by small individual local governments will be optimal. A metrowide perspective
would seem to be a minimum requirement for incentive policy to consider the full range
of economic and fiscal effects. One limitation of state governments in this regard is that
some metro areas cross state boundaries, a subject considered below.
Better Benefit—Cost Analyses. State legislatures can require that all economic devel-
opment incentive offers be subject to a prospective benefit-cost analysis to estimate
whether the incentive offer is efficient. This analysis would estimate: employment bene-
fits, including what proportion of the new jobs would likely go to local residents, partic-
ularly unemployed local residents; wage effects, including the wage rate paid on the jobs
for workers of given credentials versus current local jobs held by local residents with
similar credentials; fiscal effects, including local as well as state effects, effects on required
public expenditure as well as taxes, and analysis of the capacity of existing infrastructure
to accommodate job growth; and environmental effects. If the estimates are high-quality,
they increase the likelihood of the right incentive choices. Even imperfect estimates would
encourage debate on some relevant issues about incentives.
Job Quality and other Project Standards. As suggested by Greg LeRoy and the
organization “Good Jobs First,” as well as others, states could require that all projects
awarded incentives meet some minimum standard for job quality (LeRoy 1999; Nolan and
LeRoy 2003; Purinton et al. 2003). In theory, concerns about job quality are already
addressed as one component of the benefit–cost analysis. Decisions should be based on
the net benefits of the incentive, not just on whether the project met a job-quality stan-
dard. However, as a check on the incentive decision-making process, it might be wise to
identify in advance some minimum standards for projects, under the assumption that proj-
ects failing to meet standards would be unlikely to pass a benefit-cost test. Projects that
did not meet these minimum standards would have to go through a special review process
to be approved. These minimum standards would give economic developers a summary
of what types of projects they would be encouraged to pursue, and would give the public
and policymakers extra assurance that there is some selectivity involved in the benefit–cost
analysis process. Benefit–cost analysis is too often a “black box” dominated by technical
experts. Standards may help clarify what the benefit–cost analysis process is trying to do.
More Up-front Incentives. Studies indicate that corporate executives use very high
real discount rates in making investment decisions, averaging 12 percent (Summers and
Poterba 1994). For business location decisions, this implies that the portion of the prop-
erty tax abatement provided 10 years from now is almost completely irrelevant to the
location decision, because the business decisionmaker is focused on shorter-term profit
objectives. On the other hand, most studies suggest that governments in making decisions
should use social discount rates much lower than 12 percent. To serve the public interest,
governments should have a longer time horizon than corporate executives.
As a result, it is possible to have a greater effect on business location decisions at a
lower cost by providing a greater proportion of the incentive up front. Up-front incentives
also force state and local political leaders to immediately deal with incentives’ costs, rather
than passing on costs to their successors. However, providing more up-front incentives
brings to the forefront the issue of whether the incentive can be recovered if the location
decision does not provide the promised benefits, for example if the company relocates. To
provide more incentives up front, a greater proportion of the incentive can be provided as
customized training or infrastructure, or tax incentives can be made larger but shorter term.
Clawbacks. The net benefits of an incentive regime are increased when some of the
incentive can be recovered if the business receiving the incentive does not provide the
planned social benefits, for example, if the business relocates or the number of jobs created
falls short of projections.12 This can be dealt with by legally-binding “clawback” provi-
sions, which recover some portion of the up-front incentives if the business does not meet
performance goals. State use of clawback provisions is increasing, with the number
increasing from 9 to 17 between 1992 and 2002 (Peirce 2002). It is believed that local
use of clawbacks is also increasing. Surveys of local governments show that 59 percent
of local governments claim they “always” require a performance agreement as a condition
for incentives, and an additional 30 percent of local governments claim they “sometimes”
require a performance agreement (Bartik 2004a).
The main potential problem with clawbacks is that if they are unduly onerous, they
may be a disincentive to attracting businesses. However, if clawbacks are designed so that
incentives and clawbacks are clearly related to the social benefits associated with the busi-
ness, then businesses that expect to make a long-term investment in the community should
not perceive such a clawback as a huge disincentive to their location decision.
Redesign Incentives to Focus more on the Social Benefits of Business Growth.13 As
discussed above, the largest portion of the social benefits of growth arise from increasing
local employment rates. Increasing such rates provides the unemployed with greater job
experience, puts upward pressure on local wages, and increases local taxes more than
public spending needs. Local employment rates are most likely to go up when the new
business hires the unemployed, and least likely to go up when the new business hires in-
migrants. The rates may go up when the new business hires local residents who are already
employed, as this creates a job vacancy that may be filled by the local unemployed.
Therefore, incentives will be more targeted on the projects with greatest social bene-
fits if the amount of the incentive is based on whom the business hires. Incentives should
be somewhat greater for projects that hire local residents, and considerably greater if the
business hires the unemployed.14 More benefits of greater employment experience occur
in the first year of employment, so it would be justifiable for greater incentives to be
provided for the initial hiring of the unemployed and their first year of employment, and
somewhat smaller incentives for subsequent years. In addition to targeting incentives on
projects that provide greater social benefits, such incentives will encourage businesses to
do more hiring of the unemployed. Such hiring incentives will be more effective if tied
to local programs that attempt to screen and train potential hires from among the unem-
ployed, which I discuss next (Bartik 2001, Chapter 8). Finally, tying incentives to the pro-
vision of social benefits is an automatic “clawback,” as the incentive that is not paid until
the benefit is delivered does not need to be “clawed back” if the benefit is not delivered.
Tying Incentives to Participation in “First Source” Hiring Programs.15 Many local
governments have some nominal requirement for local hiring by businesses receiving
incentives, but frequently these requirements are unenforced because of fears of discour-
aging business locations. A few cities, such as Portland (Oregon), with its now-defunct
JobNet program, and Berkeley, with its First Source program, have tried to encourage local
hiring without adversely affecting business locations. These programs combine a moder-
ate requirement, that businesses “consider” hiring workers referred by the program, with
a public service to help businesses overcome the many difficulties they face in finding pro-
ductive workers to fill jobs with few formal credential requirements. Studies suggest that
one-quarter of new hires in small and medium-sized firms are producing less than 75
percent of what the employer anticipated after six months on the job (Bishop 1993). These
difficulties may occur in part because job performance is so dependent on “soft skills,”
such as showing up at work on time and getting along with co-workers and customers,
and these soft skills are hard to observe in the normal hiring process. Because normal
hiring so often is disappointing to employers, a program that can train and screen quali-
fied workers, who are then considered for hiring by employers receiving incentives, can
potentially help businesses find productive workers. Local public agencies may have some
comparative advantage over private businesses, particularly private businesses from out of
town, in working with neighborhood groups, churches, and social service agencies to find
productive workers for jobs with low credential requirements. Local public agencies may
also be better able than businesses to mobilize resources for training from local workforce
agencies and the local community college.
Focusing Incentives on In-Kind up-front Services such as Customized Training and
Access Roads and other Infrastructure. Customized training and infrastructure are
incentives that inherently are concentrated up front, and therefore have the advantages of
up-front incentives mentioned previously, including a greater effect on location decisions
per present value dollar of incentive. Customized training and infrastructure also are
incentives that inherently can be at least partially clawed back, without legal proceedings,
as the infrastructure and most of the trained workers will remain in the local area even if
the business relocates or downsizes. Customized training also can be designed to increase
the likelihood that a greater proportion of those trained and hired are local residents who
otherwise would be unemployed (see Batt and Osterman [1993] and Osterman and Batt
[1993] for some examples in North Carolina’s customized training programs). Finally,
both customized training and infrastructure can be justified as making public services more
effective, rather than unjustifiably treating some businesses more favorably than others.
For example, public infrastructure such as highways is supposed to be provided in response
to demand. Providing access highways as part of an incentive package is only an “incen-
tive” because the access highway is expedited to the top of the “to do” list. It could be
argued that making the provision of highways more responsive to changes in demand
makes government more responsive. It could also be argued that training programs can
increase their quality by becoming more customized to the needs of both those receiving
the training and those organizations that will demand the skills of those trained.
Federal Intervention in Incentive Policy. In theory, federal intervention could be
used to require or encourage all of these recommendations for more effective incentive
policy. However, absent some rationale for why there is a national interest in incentive
policy, there is no reason to think that federal intervention will be any wiser than state and
local incentive policies. There is some reason to think that federal intervention would
make things worse. The federal government has less knowledge about local labor market
institutions, which might be important, for example, in designing customized training pro-
grams. The federal government will also have less of other “local knowledge”: less knowl-
edge about job needs of different groups, the hiring practices of local employers, the
problems caused by particular environmentally contaminated properties, the capacity of
particular local infrastructure, and so forth. In addition, the federal government is likely
to be less responsive to local needs. Because the benefits and costs of incentive policies
depend on the details of the local labor market and local fiscal structure, effective policy-
making depends on an intimate knowledge and responsiveness to these details. Federal
intervention is at a disadvantage.
Federal government intervention in incentive policy is particularly likely to be casually
reckless if it is free of cost constraints, accomplishing its goals by regulating or taxing
state and local incentives it wants to prevent rather than subsidizing incentives it wants to
encourage. For example, some have proposed having Congress ban or heavily tax incen-
tives (Minge 1999; Burstein and Rolnick 1995). As argued previously, some incentives
have social benefits, and assuming the “federal incentive tax” was not easy to evade, a
uniform tax would discourage these beneficial incentives. For example, an economically
distressed city may find that economic development incentives are part of the best policy
package for its economic revitalization. If a federal incentive tax prevents these incen-
tives, that distressed city may have to adopt an inferior revitalization package—for
example, one that tries to make the city competitive by lowering overall business tax rates
and making cuts in redistributive public services. However, in practice I would suspect
that most federal incentive taxes would be easy to evade, so this policy would serve little
purpose except political posturing.
In theory, federal intervention could be more selective than a uniform federal incen-
tive tax, which would make the intervention more beneficial. For example, Congress could
only impose the federal incentive tax on incentives provided by affluent local areas.
However, I am skeptical that Congressional intervention would be so enlightened.16 If
Congress is able to gain revenue, or at least not lose revenue, by regulating state and local
economic development activities, I suspect that this unfettered intervention would be just
as likely to discourage efficient economic development programs as inefficient programs.
Federal intervention in incentive policy is more likely to be effective if it is: 1) tar-
geted on instances where there is a clear national interest in state and local incentive policy;
and 2) accomplished through federal subsidies rather than taxes and regulation, which
forces some awareness of costs by federal decisionmakers. Three types of federal inter-
ventions appear justified based on national interests. First, federal dollars should continue
to be provided for initiatives that seek to target economically distressed areas, such as
Empowerment Zones and the New Markets Initiative. The rationale for this intervention
is that there is a national interest in promoting a more progressive income distribution,
which such initiatives help accomplish. Second, federal dollars should be provided for
rigorous prospective and retrospective benefit-cost analyses of economic development
incentives. In the process of evaluating these incentives, such studies will disclose exactly
what incentives are being offered in different states. The incentive offers from the differ-
ent states should be compiled by the federal government into a database that would be
publicly available. The rationale for this intervention is that information on what incen-
tives are being offered, and these incentives’ effectiveness, is a public good with benefits
to economic developers and the public in all states. Third, federal dollars should be pro-
vided to help fund metrowide economic development organizations, with extra funding for
metrowide economic development organizations that extend across state boundaries. The
federal government has some advantage over the states in encouraging cooperation that
might benefit an interstate metro area as a whole.
Conclusion
Wasteful economic development incentives should be dealt with largely by opening up
the incentives policy process at the state and local level to broader public participation and
debate. To promote more effective public participation, we should continually improve
our data on and analyses of the benefits and costs of incentives. Broader public partici-
pation and better analysis should lead to the specific reforms that are favored in the above
discussion.
Such a reformed incentive policy would only offer incentives selectively, subject to an
overall budget constraint. Incentive offers would be coordinated at the metrowide or state
level. Full public information would be available on all incentive offers and their results.
Incentive offers would be subject to a prospective benefit–cost analysis, have some
minimum standards for job quality, and have provisions for recovering incentives if per-
formance goals were not achieved. Incentives would focus on encouraging more hiring
of the unemployed, for example, through hiring subsidies and customized training
grants. Economic development incentives should be seen as a part of an overall policy
to improve local labor markets. Economic development incentives should be used to
increase labor demand for those local residents who are unemployed or underemployed.
Such local demand policies should be coordinated with local labor supply policies, which
would provide the training and education needed for local residents to succeed in these
new and better jobs. In addition to overcoming barriers to the efficient working of local
labor markets, economic development incentives should be used to overcome barriers
preventing the use of brownfields, and to encourage use of underutilized public
infrastructure.
A “bottom-up” approach to reforming incentives, by working at the state and local level
to improve incentive policy, is likely to be more effective, more durable, and more demo-
cratic than a heavy-handed “top-down” approach of using federal intervention to prevent
certain practices. Federal policy can be more helpful by providing financial support for
“bottom-up” reform: subsidizing better benefit-cost analyses and information on incen-
tives, encouraging stronger coordination of incentives at the metro level, and targeting
assistance on economically distressed local areas.
Incentive reforms are preferable to incentive abolition, as there are real economic forces
that in some cases make incentives a desirable policy. Attempting to abolish incentives
will lead to even more wasteful policies to create a “good business climate.”
If one believes the government can take wise action, it is sensible to allow state and
local governments the flexibility to use incentives. We should have a reasonable faith in
state and local governments as “laboratories of democracy.” State and local experimenta-
tion in economic development incentives can lead to better public policies if the public
has the information and participation needed to allow for incentive reforms.
APPENDIX
Plausible Calculations of Medium-Term Benefits
and Costs of Economic Development Incentive Programs
for a State or Metropolitan Area
This appendix presents in table form plausible medium-term flows of benefits and costs
associated with an economic development incentive program. This table is an expansion
and updating of calculations I have previously presented in Bartik (1991a, 1992, 1994b,
2004a) and Bartik, Eisinger, and Erickcek (2003). The incentive program considered is
for a state or a metropolitan area. The benefits and costs estimated are for the residents
of the state and metropolitan area, and their governments and businesses. Benefits and
costs to the federal government, or to persons, businesses or governments outside the state
or metropolitan area, are not considered. The benefits and costs are calculated as annual
flows over some medium term after the incentives are provided, say five years. Some table
entries also speculate about shorter-term or longer-term benefits and costs. Benefits
and costs are calculated in two ways: as percentages of annual state or local personal
income for a 1 percent once-and-for-all labor demand increase to state or metropolitan
area employment, with this 1 percent employment increase induced by incentives of
average effectiveness and as real dollars, using prices of 2003, per job induced by incen-
tives of average effectiveness. This appendix will go through Table 1 line by line, explain-
ing how each line is calculated based on the research literature and various data
sources.
APPENDIX TABLE 1. ESTIMATED BENEFITS AND COSTS OF ECONOMIC DEVELOPMENT

INCENTIVES.
Category Benefits/costs as % of Benefits/costs in

local personal income annual real 2003
for 1% induced dollars per
employment growth induced job
(column A) (column B)
(1) Incentive costs -0.218 -9,699
(2) Fiscal effects

(2.1) Induced revenue from additional 0.055 2,425
business tax base
(2.2) Net incentive cost = (1) + (2.1) -0.163 -7,274
(2.3) Net long-run fiscal effects of equal 0 0
employment and population growth
(2.4) Gross effects of extra jobs on revenue 0.011 485
from business tax base
(2.5) Required public services for extra jobs -0.006 -285
(2.6) Net fiscal effects of “profit” on extra 0.005 200
business tax base = 2.4 + 2.5
APPENDIX TABLE 1. (CONTINUED)

(2.7) Reduced social spending and 0.019 845

unemployment benefits due to higher
employment rates
(2.8) Sales/income taxes on increased 0.018 795
personal income of local
residents = 3.8
(2.9) Property taxes on increased real estate 0.008 343
values
(2.10) Short-run fiscal effects: Positive if ? ?
underutilized infrastructure, negative if
growth requires expensive new
infrastructure
(2.11) Net quantifiable fiscal 0.049 2,183
effect = 2.6 + 2.7 + 2.8 + 2.9
(3) Labor market effects

(3.1) Gross real earnings gains for local 0.317 14,104
residents
(3.2) Extra real earnings on new job 0.916 40,766
(3.3) Subtracting out earnings of -0.733 -32,613
in-migrants = 80% of (3.2)
(3.4) Net earnings of local residents on new 0.183 8,153
jobs = 3.2 + 3.3
(3.5) Increase in real wages due to promotion 0.134 5,950
of local residents to better-paying
occupations = 3.1 - 3.4
(3.6) Loss of social spending transfers = 2.7 -0.019 -845
(3.7) Net increase in real income of local 0.298 13,258
residents before
taxes = 3.4 + 3.5 + 3.6 = 3.1 + 3.6
(3.8) Sales/income taxes on increased -0.018 -795
income of local residents
(3.9) Increase in income of local residents after 0.280 12,463
taxes = 3.7 + 3.8
(3.10) Reservation wages in low unemployment -0.165 -7,338
local area = 90% of 3.4
(3.11) Reservation wages in high unempl. area: 0 0
Assumed zero
(3.12) Net labor market benefits in low 0.115 5,125
unemployment area = 3.9 + 3.10
(3.13) Net labor market benefits in high 0.280 12,463
unemployment area = 3.9 + 3.11
APPENDIX TABLE 1. (CONTINUED)

(3.14) Shorter-run or longer-run labor market ? ?

benefits: Probably greater in short-run,
less in long-run
(4) Real estate effects

(4.1) Gross gains in real estate values, as 0.077 3,426
annual income flow
(4.2) Increased annual property tax -0.008 -343
(4.3) Net gain to property owners 0.069 3,083
(5) Locally-owned business effects: ? ?

Profit increase at businesses serving
local market, decrease at export-base
businesses.
(6) Environmental/congestion effects: ? ?

Likely to be negative unless project
involves restoring brownfields
(7) Community effects: Some loss in community ? ?

character and increased rents for local
residents for growth beyond original
community size, some gain for growth
that restores community’s customary size
Total quantifiable effects

(8.1) In low unemployment local labor 0.016 692
market = 1 + 2.11 + 3.12+ 4.3
(8.2) In high unemployment local labor 0.181 8,030
market = 1 + 2.11 + 3.13 + 4.3
The gross incentive costs (line (1)) are derived assuming the response of state or met-
ropolitan employment with respect to an incentive will be equivalent in gross costs to the
foregone business tax revenue to induce increased local activity if the elasticity of local
employment with respect to state and local business taxes is -0.25. As derived in footnote
(4), the gross foregone business tax revenue per induced job (line (1), column B) is dR/dJ
= (JdT)/dJ = T(1/E), where dR is the gross change in business tax revenue due to a reduc-
tion in business taxes, J is the number of jobs, dJ is the number of induced jobs, T is the
business tax rate calculated as state and local business taxes per job, dT is the change in
that tax rate, and E is the elasticity of state and local employment with respect to the busi-
ness tax rate, which is assumed to be -0.25, a compromise between the -0.3 preferred in
the literature review of Bartik (1992) and the -0.2 preferred by Wasylenko (1997). Busi-
ness tax revenue per job is calculated as detailed in endnote (4) of the paper. Line (1)(A)
is derived in similar a manner, using the equation that the foregone taxes as a percentage
of income to induce 1 percent employment growth will be = 100(dT/Y) = ((1% employ-
ment growth)/E)(T/Y), where T is now business taxes in dollar terms, Y is personal income,
and state/local business taxes as a percent of personal income are assumed to be 5.46
percent, based on calculations in Bartik (1991a, p. 180).
Lines (2.1) through (2.2) present a side calculation showing fiscal effects and net incen-
tive costs if the only fiscal effect considered is the extra business tax revenue from
enhancing the business tax base. This extra business tax revenue is simply the business
tax revenue associated with the induced jobs. Line (2.1)(B) is business tax revenue per
job in 2003 dollars, based on calculations in endnote (4), as the (B) column expresses
everything per one induced job. Line (2.1)(A) is 1 percent of average business tax revenue
as a percent of personal income, because the (A) column expresses everything per 1 percent
in induced extra employment. Line (2.2) then shows a supposed “net incentive cost,” which
is however erroneous because it omits all the fiscal effects from the public services asso-
ciated with the extra business tax base, as well as the taxes and public services associated
with the extra households, and the effects of higher employment on the need for social
services and revenue from the property tax. This erroneous calculation is the style of cal-
culation frequently done by advocates for incentives who claim that such incentives “pay
for themselves.” Line (2.2) shows that such incentives clearly don’t pay for themselves
even if we only look at the business tax base gains.
To simplify the analysis of the full fiscal effects, I start from the baseline of the long-run
fiscal effects of employment growth and population growth when both increase by the same
percentage. This baseline is straightforward to analyze, and the actual net fiscal effects of
the incentive-induced growth are then analyzed as effects of deviations from this baseline.
Line (2.3) assumes that if state and local public services are constant returns to scale in the
long-run, as indicated in Fisher (1996) and Inman (1979), a balanced increase in employ-
ment and production should produce equal tax revenue and public service needs. But of
course we don’t expect that induced jobs will bring about the same percentage increase in
population. Based on Bartik (1991a, 1993), we expect that for a given percentage increase
in induced employment, the percentage increase in population will be about four-fifths as
much. So we analyze the fiscal effects as if for every 1 percent in induced jobs, we have four-
fifths of 1 percent in increased population. The fiscal effects then are a combination of a
“balanced” increase of four-fifths of 1 percent in both employment and population, which
should have zero fiscal effects in the long-run, and the fiscal effects of the “extra” one-fifth
of 1 percent of jobs. The effects of these extra jobs are the effects of these extra jobs on the
business tax base and required public services, as well as the effects of the extra jobs, via a
higher employment rate, on the taxes and transfers associated with higher earnings for local
residents, considered in the section on labor market effects.
Line (2.4) calculates the business taxes from the extra jobs as one-fifth of the business
taxes from the business tax base associated with all the jobs, from line (2.1). Line (2.5)
is based on Oakland and Testa’s (1996) calculation that business tax revenue is 70 percent
greater than public services directly required by businesses. Line (2.7)(A) is based on esti-
mates from Bartik and Eberts (1999) that 1 percent employment growth reduces welfare
caseloads by 6 percent, and estimates by Chernick and McGuire (1999) that own-source
state and local spending on social services is 1.3 percent of personal income; social serv-
ices spending is assumed to decline by the same percent as welfare caseloads. This yields
a decrease in social services spending as percent of income of -0.008 percent. This may
seem small compared to overall earnings gains of 0.317 percent (see line (3.1) below), but
growth is only modestly progressive; about 4.2 percent of the total earnings gains from
stronger regional labor demand goes to the bottom income quintile, which is not much
more than their share of income (Bartik, 2001, Table 5.3). In addition, line (2.7)(A) is
based on estimates (Bartik, 1991b, Table 2) that 1 percent extra local employment growth
in the short-run reduces unemployment payments by 3.4 percent. Based on 1995 statis-
tics from O’Leary and Wandner (1997, page 733), and 1995 personal income data from
the Regional Economic Information System, UI benefits are 0.33 percent of personal
income, so a 3.4 percent reduction in such payments will reduce unemployment benefit
payments by 0.011 percent of personal income. Adding 0.011 percent to the 0.008 percent
reduction in social spending yields the 0.019 percent figure shown in line (2.7)(A). Line
2.7(B) is derived from (A) by using ratios. Line (2.8) is based on the taxes associated with
the extra earnings of local residents, and will be discussed further when the labor market
section of the table is discussed. Line (2.9) is based on the property taxes on the increased
real estate values associated with growth and is discussed further in that section. Line
(2.9) is based on case studies by Altshuler and Gomez-Ibanez (1993) that show that new
required infrastructure frequently vastly exceeds tax revenue from growth; because exist-
ing infrastructure will eventually require replacement, this suggests that depreciation
charges for existing infrastructure are understated.
Line (3.1)(A) is based on estimates reported in Bartik (1991a, p. 163) on effects of
growth on real earnings, expressed as a percent of personal income by assuming earnings
are 73.5 percent of personal income (Bartik, 1991a, p. 163). Line (3.1)(B) uses ratios to
calculate this on a per job basis. Lines (3.2) through (3.5) attempt to divide line (3.1) into
various components: gains for workers newly employed, vs. gains for workers already
employed who get better jobs. Line (3.2) attempts to replicate what a naive benefit-cost
analysis would assume about earnings gains: they are equal to the earnings on the induced
jobs. Line (3.2)(B) is based on dividing total earnings by total employment, using 2002
data from the Regional Economic Information System. Line (3.2)(A) uses ratios to cal-
culate this as a percent of personal income. Line (3.3) subtracts out the earnings of in-
migrants to get the effects on local residents who get jobs in line (3.4). The rationale for
subtracting line (3.3) is twofold, first, this analysis takes a local perspective in which only
the original residents count and second, the analysis in Bartik (1991a) suggests that the
well-being of in-migrants is not substantially affected by extra jobs in this local area, as
the in-migrants would otherwise move to a similar local area. After subtracting line (3.4)
from line (3.1), the remaining earnings gain must be from local residents moving up to
better paying jobs. The residual calculation for line (3.5) appears roughly consistent with
data from Bartik (1991a) on how employment growth affects occupational upgrading for
local residents. The loss of transfer income in line (3.6) was previously derived for line
(2.7). Line 3.8 is based on estimates from Citizens for Tax Justice that state and local per-
sonal sales and income taxes in 1995 averaged 6 percent of income for households in the
middle income quintile (Ettlinger et al., Appendix 1, p. 51). In line (3.10), the reserva-
tion wage figure of 90 percent is used in Bartik (1991a) based on a review of the reser-
vation wage literature. The assumption that reservation wages are zero for the unemployed
in high unemployment areas is arbitrary. This assumption might be justified, even if
nonwork time has some value for the unemployed, as seems likely, if unemployment has
sizable social costs such as increased crime or increased social problems for the children
of the unemployed. Lines (3.12) and (3.13) emphasize how different the labor market ben-
efits are based on different assumptions about reservation wages. Line (3.14) reflects that
estimates suggest that the earnings effects reported in this table for local residents are prob-
ably greater in the short-run and less in the long-run than the medium-run figures used
here (Bartik 1991a; Bartik 1994b). The question mark for line (3.14) suggests that it is
unclear how this would affect a present value analysis compared to simply using the
medium-run annual flow benefits and costs reported in the table.
Line (4.1)(A) comes from Bartik (1994b, Table 3), and is based upon estimates by Bartik
(1991a) that 1 percent employment growth increases real estate values by 0.451 percent. A
10 percent real discount rate is used to convert changes in capital values to annual flows.
Line (4.1) (B)is derived from (A) using ratios. Line 4.2 is based on Table 3.13 of the 2001
American Housing Survey, which estimates that the median residential property tax rate for
owner-occupied housing is 1 percent of value (the AHS is available from the U.S. Census
Bureau at http://www.census.gov/hhes/www/housing/ahs/ahs01/ahs01.html).
The line (5) discussion assumes that only locally-owned businesses should be consid-
ered in this local benefit-cost analysis. This is consistent with this analysis focusing on
the perspective of the state or metropolitan area, and ignoring effects on the federal gov-
ernment, or other state or metropolitan areas. Growth will clearly increase nominal wages
and prices, as shown in Bartik (1991a), which reduces profits for businesses selling to
outside markets. But businesses with some comparative advantage that they can maintain
as the area grows (e.g., a local newspaper) will likely increase profits due to growth, as
discussed in Bartik (1991a).
For more discussion of environmental effects of local economic development, and of
brownfields, see Bartik (2004a).
The line (7) entry assumes that in a world with imperfect mobility, changes in a com-
munity’s “character” that bring it away from the originally chosen amenity package of the
area’s households, with the accompanying wage and price changes, will reduce utility of
the area’s original residents, as these original residents must have preferred the original
amenity package given prevailing wages and rents. For more on this type of model, see
Bartik (1991a, pp. 73-76), and Bartik (1986).
There is considerable uncertainty in these figures; for example, I could come up with
a rationale for adjusting the incentive cost figures and the earnings gains numbers up or
down by 50 percent or more. Stating the numbers in this table to three, four or five digits
is an aid to calculation, but is a misleading indication of how much we really know. There-
fore, it would be relatively easy to come up with a scenario under which quantifiable net
benefits of economic development in a low unemployment area are negative.
NOTES
1. I have previously written about incentives in Bartik (1990, 1991a, 1993, 1994a, 1994b, 1994c,
1996a, 1996b, 2001, 2003, 2004a, and 2004c), as well as in Bartik, Erickcek, and Eisinger (2003).
My comments on the benefits and costs of incentives from a state and local perspective are rea-
sonably consistent. As I will footnote later, my comments on federal intervention in incentives
have some inconsistencies.
2. This counts as cash or near-cash incentives to large businesses the following Michigan programs:
property tax abatements, one third of tax increment financing, MEGA tax credits, brownfield tax
credits, Renaissance zones, and federal Empowerment Zone/Enterprise Community funding.
Together these programs comprise $531 million of the $706 million in annual Michigan eco-
nomic development resources. Michigan also spends $13 million on customized job training,
$60 million in federal community development block grants on infrastructure development for
economic development in nonurban communities, and $48 million on business recruitment and
retention. The remainder of Michigan economic development resources are devoted to small
business development, high tech research, and manufacturing extension.
3. Although this is the general consensus, not all scholars agree that state tax effects on business
location are significant. The most prominent scholarly critic of the notion that state taxes affect
business location is McGuire. McGuire admits, however, that her position is inspired in part by
fears of how state policymakers will respond to the conclusion that taxes affect business loca-
tion. According to McGuire:
. . . I confess to being somewhat (perhaps very) irrational in my interpretation of this literature.

With respect to the interstate and interregional studies, despite the number of studies with signifi-
cant coefficients, I find it difficult to be convinced that taxes are an important factor in explaining
differences in business location decisions and economic activity between states or regions. In part,
I believe the discrepancy between my conclusion and that of many other scholars of the topic is due
to our different perspectives. I came to this topic through the tax-study, blue-ribbon-commission
route. I have seen firsthand state policymakers grasping for straws. I simply do not think that the
evidence allows us to comfortably advise lawmakers that reducing the corporate income tax rate or
the personal income tax rate will revive a flagging state economy. (McGuire 2003)
4. This calculation is as follows: The tax elasticity of private employment with respect to state and
local business taxes (E) is defined as (dJ/J)/(dT/T), where J is the number of jobs, dJ is the change
in the number of jobs, T is the tax rate, and dT is the change in the business tax rate. The per-
centage change in revenue from a tax cut, dR/R, will approximately equal dT/T = dJ/J.
Substituting and rearranging, one obtains, for the net foregone revenue cost per job created,
dR/dJ = (R/J)[1 + (1/E)]. R/J is state and local business tax revenue per job, which was about
$1,634 per job in the United States as of 1989. With a value of -0.25 for E, one obtains dR/dJ
= -$4,902. Updating by the change in consumer price index from 1989 to 2003 gives a figure
in 2003 dollars of (184/124)4,902 = $7,274. The figure of $1,634 for state and local business
taxes per private employee comes from three sources. Total state and local tax revenue in fiscal
year 1989 was $469 billion (Bureau of the Census, Government Finances: 1988-89 [Washington,
DC: GPO, 1991], 21). One estimate of the business share of state and local taxes is 31 percent
(ACIR, Regional Growth: Interstate Tax Competition, Report A-76 [Washington, DC: ACIR,
March 1981], revised version of table A-1; figures for 1977). Private nonagricultural employ-
ment in the United States averaged 89 million during fiscal year 1989 (Department of Commerce,
Bureau of Economic Analysis, Survey of Current Business [January 1991]: S-10). These figures
could be updated using more recent data, but most of the studies were estimated using earlier
data, so use of this historical data is probably better. The elasticity used is a compromise between
the -0.3 preferred in the literature review by Bartik (1992) and the -0.2 preferred by Wasylenko
(1997). The Consumer Price Index figures come from the U.S. Bureau of Labor Statistics. I used
an identical calculation in Bartik (2004a, 1992). The dynamic calculation here only looks at
effects of taxes on the business tax base, and ignores extra public expenditures required by a
higher business tax base, and extra taxes and required public expenditures because of a larger
household tax base.
The cost in static tax revenue is dR = JdT, which, per job created by lower business tax rates,
is JdT/dJ = T (1/E) = (business tax base per job)(1/0.25). Using the same figures, the loss in
static revenue from a business tax cut in 2003 dollars is $9,699 = 1,634(184/124)(1/0.25).
5. Derived from Fisher and Peters (2002, Table 3.7). This takes their present value of incentives
per job in the highest subsidy city and state of $22,678 in 1994, translates this into an annual
equivalent by multiplying by the 10 percent discount rate used by Fisher and Peters, and then
adjusts to a 2003 value using the Consumer Price Index, or (184/148.2) ¥ (0.10)(22,678) = 2,816.
6. An annual subsidy of $2,816 per job will yield a gross cost of $9,699 per induced job, as previously
calculated, if the proportion of induced jobs (p) satisfies the equation p = $2,816 / $9,699 = 0.29.
7. These calculations are based on Fisher and Peter’s figures for the mean value of “general incentives”
per job in 1994 in their Table 3.7, translated into an annual equivalent and updated to 2003 dollars.
8. What about migrants? I explore this in Bartik (1991a, Chapter 3). The argument is that persons
on the margin of migrating in, or migrating out, do not have their opportunities substantially
affected by changes in the characteristics of this one local area. If the local area had remained
unchanged, with no growth, the persons who would have otherwise migrated in would choose
other, similar metropolitan areas. Similarly, the individuals whose outmigration is averted by
growth are by definition close to indifferent between staying or moving.
9. For more “market failure” analysis of state and local economic development policy, see Bartik
(1990, 1994c) or Courant (1994).
10. Sinclair 1994 reprint of 1935 book, p. 109.
11. This fiscal impact analysis is imperfect. The fiscal impact analysis only looks at state revenues,
and not at state expenditures, or local taxes and expenditure. In addition, a full benefit-cost analy-
sis would include labor market benefits. A more detailed discussion of MEGA is in Bartik, Erick-
cek, and Eisinger (2003).
12. More extensive discussion of clawbacks is found in Peters (1993) and Weber (2002).
13. This is advocated by Bartik (2001) and by Schweke and Woo (2003).
14. Favoring the unemployed in jobs associated with business subsidies would seem likely to be
acceptable discrimination from a legal perspective. Favoring local residents is more open to
question.
15. More on “First Source” programs is in Bartik (2001, Chapter 9); Schweke (1999), Anderson
(1999); and Molina (1998).
16. I have been inconsistent over the years in my comments on federal regulation of incentives. I
have sometimes been tempted by the notion that the federal government should intervene to
prevent the wasteful incentives of state and local areas with low unemployment. In the current
political environment, I am pessimistic that an intervention that comes at no federal cost, such
as taxing incentives, would be so benign as to simply target wasteful incentives.
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Growth and Change

Vol. 36 No. 2 (Spring 2005), pp. 139-166

Submitted June 2004; revised Dec. 2004

The Forces Leading to Incentives

FIGURE 1. RELATIVE TRANSPORTATION AND COMMUNICATION COSTS.

Alternative Incentive Reforms

APPENDIX TABLE 1. ESTIMATED BENEFITS AND COSTS OF ECONOMIC DEVELOPMENT

Category Benefits/costs as % of Benefits/costs in

(1) Incentive costs -0.218 -9,699

(2) Fiscal effects

APPENDIX TABLE 1. (CONTINUED)

Category Benefits/costs as % of Benefits/costs in

(2.7) Reduced social spending and 0.019 845

(3) Labor market effects

APPENDIX TABLE 1. (CONTINUED)

Category Benefits/costs as % of Benefits/costs in

(3.14) Shorter-run or longer-run labor market ? ?

(4) Real estate effects

(5) Locally-owned business effects: ? ?

(6) Environmental/congestion effects: ? ?

(7) Community effects: Some loss in community ? ?

Total quantifiable effects

. . . I confess to being somewhat (perhaps very) irrational in my interpretation of this literature.

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