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Purpose of Economic Incentives

by John Lenio - February 17, 2010

Purpose of Economic Incentives
  By: John Lenio

Economic incentives are intended to lure businesses that will significantly expand the tax base, employ local residents, have a catalytic effect on local suppliers, are in a job-growing mode, and creates local wealth. Incentives cannot turn a bad location with inadequate workforce or infrastructure into a good location. However, incentives are the most persuasive when location factors are relatively equal between locations and can either level the playing field or be the deciding factor among a short list of locations.

Economic incentives have three functions: address cost disadvantages, revitalize distressed regional economies, and induce favorable economic activity.

Address Cost Disadvantages:
There are a number of site selection factors and operating costs that cannot be controlled in the near term. These include labor costs, available workforce skill levels, real estate availability & cost, transportation infrastructure (to an extent), and geography. For example, consider an economic development prospect that needs to hire 500 financial analysts. Metro Phoenix and Metro Tampa are on the final two locations on the short list. Our focus will be on total labor cost since it accounts for 70% to 80% of these types of operations. According to latest occupational wage survey conducted by the U.S. Bureau of Labor Statistics, the median wage for a financial analyst in Metro Phoenix was $31.17 per hour. By comparison, the median wage in Metro Tampa was $28.20 per hour. This $2.97 per hour difference in wages results in total labor costs that are $3 million per year higher in Metro Phoenix (or $30 million over a 10-year time period).

Overall, strategically targeted incentives can help offset some or the entire cost disadvantage for a particular industry when such a disadvantage is otherwise likely to result in the loss of such an investment and employment. All things being equal, the lack of incentives to offset the labor cost disadvantage for the prospect in the above example will likely mean a lost opportunity.

Revitalize Distressed Regional Economies:
Incentive programs can be designed to encourage businesses to locate in a particular region where unemployment & poverty have been historically high and private investment has lacked other more affluent regions in a state. Offering enhanced incentive savings or even exclusive incentive opportunities to businesses investing in the revitalization areas can help support job creation and investment to these regions when they otherwise would not occur.

For example, Arizona’s Enterprise Zone program is focused on providing corporate income tax credits and some property tax abatements to businesses locating in established enterprise zones across the State. Yuma County is a certified enterprise zone and any business locating in the Yuma County is entitled to these incentive benefits. Indeed, the Greater Yuma EDC actively markets these target incentive benefits to most prospects evaluating Greater Yuma for a new location – whether manufacturing, distribution, or call center operations.

Overall, the absence of incentive programs targeted for these relatively economically disadvantaged areas could cause prospective businesses to look elsewhere. The sign of a good economic development policy is to not be one size fits all but to be flexible and customizable to the dynamics (pitfalls and all) of a State’s regional economies.

Induce Favorable Economic Activity:
Incentives can be designed to encourage the recruitment of businesses in basic industries. These types of industries export outside the local economy and bring net wealth in or substitutes for imports to the local economy. Basic industries produce relatively substantial ripple effects throughout the economy. These ripple effects are measured in terms of jobs, payroll, and particularly new tax revenues to the State.

For example, consider two economic development prospects are asking for incentives. One prospect is a 100-job computer manufacturing operation and the other prospect is a 100-job warehousing operation. The 100 jobs created by the computer manufacturing business will likely create an additional 218 jobs resulting in total economic activity estimated at $31.7 million annually. By comparison, the 100 jobs created by the warehousing operation will likely create only 59 additional jobs with total economic activity estimated at $8.3 million annually. The question is: Where will $1 million in incentives have the greatest return on investment in Arizona – the computer manufacturing business or the warehousing business?

Overall, incentive programs can be designed to provide benefits to industries that will have the greatest employment and fiscal benefits to a State, diversify the employment base, and especially bolster & protect certain industries that are given legislative priority.

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