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Economic Development Incentives: A Necessary Evil?

Russell S. Sobel, Ph.D.

Are Selective Incentives the Answer?

Are Selective Incentives a Necessary Evil Given Bad Business Climate Rankings (e.g., bad policies)?

What is the Evidence on Their Effectiveness from the Economics Literature?

What are the True Costs / Side Effects?

Spending on Incentives
Total all U.S. states, cities, & counties spend over $80 billion per year.

There are 21 states spending more than one billion and another 10 that give between $500 million and a billion.
Top 10: Texas Michigan Pennsylvania California New York Florida Ohio Washington Massachusetts Oklahoma $19.1 billion $ 6.6 billion $ 4.8 billion $ 4.2 billion $ 4.1 billion $ 4.0 billion $ 3.2 billion $ 2.4 billion $ 2.3 billion $ 2.2 billion

Source: December 2012, the New York Times

Spending on Incentives

Spending on Incentives

Kansas spends at least $1.01 billion per year on incentive programs, or roughly $355 per capita, or 17 per dollar of state budget Top Incentives by type: $866 million in Sales tax refund, exemptions or other discounts $118 million in Corporate income tax credit, rebate or reduction $14.7 million in Personal income tax credit Top Incentives by industry $274 million in Agriculture $156 million in Manufacturing $6.54 million in Technology

Economic Theory to Understand

Frederic Bastiat - The Seen and The Unseen/Broken Window Fallacy

We must consider the unseen costs of what is given up when resources are used for incentives (What else the money would have created if left in the private sector, for example) We must also focus on NET job creation (subtract ones who change jobs to be employed by incentivized firm)

U.S. Auto Plant Investments *

Hyundai Toyota Nissan Honda GM Mercedes BMW Toyota

Alabama Alabama Mississippi Alabama Michigan Alabama South Carolina Kentucky

Announcement Date 2002 2001 2000 1999 1998 1994 1992 1986

Initial Employment Estimate 2,000 350 4,000 1,500 700 1,500 1,900 3,000

Announced State and Real Real Incentives Local Incentives Incentive (2001 Million) (Millions) Cost per Job $118 $29 $295 $158 $107 $253 $130 $147 $118 $29 $299 $165 $114 $289 $155 $214 $59,000 $82,857 $74,835 $110,290 $162,287 $192,730 $81,479 $71,404

*Inflation adjustments are made using GDP deflator series. Includes only primary real incentive, not additional ongoing incentives. 2002 dollars assumed equal to 2001 dollars. Source: Division of Research; University of South Carolina, 2002. Economic Impact of BMW

Economic Findings on Development Incentives

Problems with Selective Incentives

Evidence is they arent very effective and have high costs per job created They create an environment of favor seeking and Unproductive Entrepreneurship [William Baumol]
Girl Scout Cookie Example

Doesnt help small businesses and may make it worse for them
Taxes on them are higher and they have to compete with the favored firms

Thank you / Q&A