Lately, I have been reading some of the scholarly work on tax incentive as an economic development tool. I admit, I am perplexed why so many economic development organizations choose to compete with incentive packages for capital attraction, retention and expansion projects. The practice is clearly widespread and well entrenched, so there must be something I am not fully understanding to explain why tax incentive packages are judged as such an important tactic.
Here are some examples of what I have been reading:
- Todd Gabe and David Kraybill authored a paper entitled – “The Effect of State Economic Development Incentives on Employment Growth of Establishments (PDF)” which was published by the Journal of Regional Science in 2002. The authors conclude “Empirical findings indicate that incentives have very little (or even a negative) effect on actual growth and they have a substantial positive effect on announced growth.” Net, companies have a tendancy to overestimate job creation when financial incentives are part of the competitive package for location selection.
- In 2009, The Chicago Metropolitan Agency for Planning published a white paper on the value of incentives. They researched 50 different How to Win tactics as part of their GO TO 2040 Regional Strategic Plan. The white paper cites work by Peters and Fisher in 2004 that estimates state and local governments expend $50B in incentives annually as an economic development tactic. The paper concludes the literature reports mixed results, but the best chance to ensure an ROI for incentives is to link their use to a specific strategic objective and to avoid using incentives for job creation that is not genuinely incremental.
- Timothy Bartik’s paper (published in 2005) entitled “Solving the Problems of Economic Development Incentives (PDF)” was interesting. He decided eliminating incentives as a tactical choice was highly unlikely, so the best course of action is to figure out how to create incentives that deliver a positive ROI. He argues “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 opportunities of local residents.” Consequently, if the ROI could be better measured, better choices on when to use incentives would be made.
There are a number of other interesting papers that left me with the gut feel tax incentives are not particularly effective, but no economic development organization wants to be the first to stop offering incentive dollars when competing for capital investment. It feels a bit like the economic development industry equivalent of the arms race. And, of course, like the arms race taxpayers under write the use of incentives.
I think there is an alternative to tax incentives worth serious exploration. I’d like to suggest consideration of competing on time-to-market as potentially a better way for many capital investment deal opportunities.
In business, time-to-market can have significant financial value. In many cases far more significant than the amount of money that a state or community could realistically consider offering in a tax incentive package. In some cases, time-to-market can literally mean the difference between a product’s commercial success or failure.
For perspective, every day a product is not available in the market, company revenue is reduced by sales lost to competitors or to technological obsolescence. Minimizing time-to-market is a strategic goal of virtually every company.
Here’s an easy equation that gives you a rough way to think about the value of time-to-market.
Value of reduced time = time savings (in weeks) * unit sales per week * margin per unit
In my experience, the estimate of unit sales per week reflects a week of peak sales. The theory is any delay in time-to-market delays the company ability to book peak sales (and consequently peak profit). This can be an amazingly large amount of money when calculated. For most companies, if you can trim several weeks from their time-to-market you will be creating a significant positive impact on the Net Present Value of their project investment. In most cases, this will far exceed the money you would realistically consider offering a tax incentive package.
There are likely any number of ways a state or community can help positively impact time-to-market. For example, simply getting permits processed on an expedited timing will help. My guess is if reducing time-to-market was the strategic focus when comprting for capital investment, many additional and creative solutions would be found.
I would like to hear your ideas on how states and communities could reduce time-to-market for companies. What if an economic development organization offered a guaranteed time-to-market on the aspects they could influence? What would those aspects be and how competitive for capital do you think such an offer would be (particularly versus an incentive package)? Are there any other papers you’d recommend I read on the subject?
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