Good Practices in Economic Incentive Programs
Incentives, grants, training programs, and other inducements are policies designed by government to enhance a location’s competitiveness, create a local benefit, or otherwise induce a company to make a location decision that they might not otherwise make. And just like any other tool, they can only be used effectively if those applying it understand the problem they are trying to solve, and then bring the right policy to the table.
At EBP, we have developed approaches for not only evaluating the performance of these important and controversial tools, but we have also developed and helped jurisdictions implement good practices in constructing incentive policies that benefit both community and recipient.
Investment incentives are policies and programs that attempt to lure more and larger investment and employment into a location using funding, credits, or other inducements. These programs may also be used to lure companies to relocation from one sub-national jurisdiction to another within the same country – a common practice, for example, in the United States. Advocacy groups have emphasized academic evidence that remains skeptical about the effectiveness of incentives, arguing that incentives do not influence business decisions to nearly the extent policymakers claim nor are they properly targeted to businesses and industries that can offer the greatest economic and social benefit.
If the awarding of incentives is to accomplish the goals of increasing economic viability of a region, attracting more or better paying jobs, increasing the overall tax base, and/or encouraging the development of new industry clusters, then such policies need to reflect both an understanding of the competitive landscape and of how to create true mutual benefit between the public and private sectors.
How Incentives Work
Credits and other incentives may also be either awarded in advance to defray start up or related costs or over time based upon the project and company meeting key performance thresholds. Awards in advance may enhance the initial financial feasibility of a project but pose increased risk for the jurisdiction as the project may never realize the promised investment and hiring goals. Many communities employ so-called “clawback” provisions to attempt to reclaim incentive awards if promised investment levels are not achieved. The practice of waiting for companies to meet key investment and hiring thresholds before receiving promised awards (performance-based incentive awards) reduces the risk to the participating jurisdiction.
General Incentive Program Best Practices
Economic Development incentive programs work best when they take the following factors into account:
The revenue lost due to the incentive award will ideally be made up for additional tax revenue from economic activity and population growth. However, government spending will also grow as new job opportunities draw in additional population, boosting demand for government services such as transportation and public safety. The net budget cost—the incentive’s initial cost, plus the increased spending needs, less the increased revenue—depends on the relative strength of these three effects, and a thorough analysis must account for these contrasting budget impacts.
Creation of Net Local Income
Giving incentives to companies that sell their goods locally, such as retailers, will tend to harm other businesses in the community and undermine the program’s potential economic benefits. However, incentives given to businesses such as manufacturers that primarily sell their products outside the state or community are more likely to deliver local economic return on investment for the incentive because those firms bring in new dollars and jobs.
Assessment of Company Impact
When a company relocates or expands because of an incentive, the effects cascade through the economy. As the firm buys goods from other local businesses and new employees spend a portion of their wages locally, some additional jobs are created in a process called a multiplier effect. It is important for incentive evaluators to consider whether the targeted industries, activities, and recipient companies are likely to have high or low local multipliers.
Design and Accountability
Businesses prefer to receive funds earlier as it will improve the overall feasibility of the project and enhance the company’s financial reporting. Therefore, a front-loaded program is more valuable to the recipients, has more influence over their decisions to invest. However as noted an incentive delivered far in advance of the business’s investment can be wasted if the company does not follow through on its plans. Incentive payments that coincide with agreed-upon job creation targets can provide a high value to businesses while protecting public resources. Likewise, all parties involved (including and especially the general public) should be given as complete predictability and transparency into the award process as possible.
Generally, economic development leaders and policymakers should design and deploy incentives policies that align with broader economic objectives, embrace public transparency and rigorous evaluation, and only target firms that advance broad-based opportunity.5 An economic development policy is a tool that acts as an expression of a jurisdiction’s economic development and investment strategy. The strategy must inform the tool and its use, never the other way around.
At EBP, we help our public sector both evaluate the performance of existing incentive and economic development programs, and assist in developing new policy founded in effectiveness, transparency, accountability, and mutual benefit.
Keeping the Balance
For many years, our professionals have been advising the State of Maine on their various economic development incentive programs. From 2013-2018, we were the retained consultants working for the Department of Economic and Community Development to produce the bi-annual Comprehensive Evaluation of Maine’s Research & Development and Economic Development Incentive and Investment Programs. The initiative examined over 50 programs run or managed by the State and made observations on their return on investment, ability to achieve stated goals, and match to private sector needs.
Currently, we are providing technical support to the Maine State Legislature’s Office of Program Evaluation and Government Accountability, focusing on the state’s three largest programs:
Employment Tax Increment Financing (ETIF)
Pine Tree Development Zones
Maine New Markets Capital Investment Program
The evaluation work includes surveying of participants, economic impact modeling to estimate broader economic consequences of business growth impacts, and quasi-experimental statistical analysis to sort out net program impacts from gross observed pre/post changes. EBP's work will help the Maine Legislature promote economic growth by improving program design, monitoring, and effectiveness.
We have also taken the lessons learned from this evaluative work to help governments design transparent and predictable incentive programs that enhance competitiveness while also providing net benefits to the jurisdiction. In 2020, EBP worked with the member jurisdictions of the Alberta’s Industrial Heartland Association to write individual bylaws, applications templates, and review procedures in support of the Heartland Incentive Program. The local tax abatement programs were designed to leverage and coordinate with credits available from the province of Alberta and work to similar qualification criteria. The resulting award system provides a tool that results in a performance-based award structure similar to that in competing jurisdictions in the US, accelerates capital investment and property tax growth in the region, and – critically – provides a tool for economic diversification. The program was recently awarded a 2021 Excellence in Economic Development Award from the IEDC.
Incentives can be a powerful and effective tool in the economic development toolbox. Used effectively, they may be used to drive economic growth, job creation, and even to spur diversification, the growth of new clusters, and address economic imbalances. However, as with any tool it is necessary to read the manual, ensure that the right tool is used for the right purpose, and – every so often – ensure proper testing and maintenance. EBP’s analysts and policy experts have the knowledge, experience, and means to help jurisdictions build good policy and develop the metrics that provide needed transparency and accountability.