The Bullish End to State Tax Incentive Bidding Wars

As the country continues to struggle with the impact of the COVID-19 pandemic, state and local governments facing budget shortfalls have had to make some hard choices. One choice, however, should be easy: moving away from targeted tax incentives in favor of comprehensive tax reform.

In normal economic circumstances, states and localities often attempt to spur economic development by offering businesses temporary, targeted tax incentives in order to move to their jurisdiction. One well known episode was the bidding war for Amazon’s new headquarters, with some localities going so far as to offer Amazon the revenue from the income taxes of its own employees.

Unsurprisingly, such generous incentives have an impact on the bottom lines of the localities and states offering them. Even before the Amazon sweepstakes, the Brookings Institution estimated that states and localities forwent between $45 billion and $90 billion a year due to targeted tax incentives.

Conservatives might be tempted to view these deals favorably, as the recipient businesses often see (temporarily) lower tax liabilities, but to do so would be to overlook important context.

First and foremost, targeted tax incentives are often a lazy workaround for states and localities with punitively high tax rates to attract businesses without fixing the underlying flaw — New York Governor Andrew Cuomo gave the game away when he complained that New York had to offer tax incentives because otherwise business would go to lower-tax states. The research backs up this anecdote, as the Mercatus Center found that states with high unemployment, high income tax rates, and high government spending are more likely to offer targeted tax incentives.

This leads into the second problem with tax incentives — they create an unlevel playing field. New businesses receiving reduced tax rates are often competing directly with established businesses, most of whom do not enjoy similar tax reductions. A Louisiana review of its economic development program found that as much as 90 percent of the economic benefit from businesses brought to the state was offset by losses among established Louisiana businesses.

This highlights a third problem, one which may be of the most interest to budget-crunched state and local legislators, which is that targeted tax incentives are not effective at accomplishing their stated purpose. A Mackinac Center analysis found that only one in ten jobs “created” by economic development incentives are actually attributable to the incentives themselves — in other words, many businesses move where they wanted to anyway, then accept the “incentives” their destinations offer as an added bonus.

With this in mind, it’s good for taxpayers that dumb economic incentives are among the first policies on the chopping block for states and localities. As governments have increasingly looked to claw back promised tax incentives for high-profile deals which have fallen apart, cutting back on wasteful targeted tax incentivesand reforming codes to be more neutral could prove to be a smart approach to dealing with pandemic-induced budget reality.

The end of tax incentive bidding wars can only be a good thing for the economic climate of the country. Forced to rely on the merits of their tax regimes without special tax breaks, states and localities may just end up designing more business-friendly tax codes which encourage economic growth. That would be a great way to get the economy back on track after a difficult year.