Showing the Way on Tax Incentives

States have used tax incentives for decades to encourage businesses to locate, hire, expand and invest within their borders. But those incentives have become even more important as states try to strengthen their economies and recover from the Great Recession. While no state regularly and rigorously tests whether these investments are accomplishing those goals, pockets of good practice can be found in states all across the country.

Much is at stake. These incentives are costing states billions of dollars each year in tax credits, exemptions and deductions for businesses in specific industries — such as manufacturing or movie production — and for firms willing to locate in struggling neighborhoods or pledging to hire new workers.

A key question policymakers should be asking is how well these incentives work. Unfortunately, some states don't even ask. Others rely on incomplete, conflicting or unreliable information. According to a recent study from the Pew Center on the States, half of the states have not taken even basic steps to produce good evidence of whether these tools deliver a strong return on taxpayer dollars and then use that evidence to make decisions about continuing to invest. No state regularly and rigorously tests whether these investments are working and ensures that lawmakers consider this information when deciding whether to use incentives, which industries and businesses should receive them, and how much to spend.

When states lack evidence on how well these investments are working, they may be missing opportunities to spend money on incentives that would create jobs. They also may be unnecessarily forgoing billions of dollars in revenue that could be used for education, transportation, health care and other critical services.

But it's not all bad news. Pew's report had four policy options for state leaders who want to measure the impact of their subsidies and weigh that evidence in their policy deliberations. In each of these areas, states are using promising approaches that others might emulate:

• Build evaluation of incentives into policy and budget debates. Under a new Oregon law, tax credits expire after six years unless lawmakers act to extend them. During budget deliberations in 2011, legislative leaders set a spending cap on the expiring incentives, driving policymakers to rely on evaluations to make tough choices about which investments should continue and in what form.

• Develop a schedule to review incentives. In 2006, Washington State began a 10-year process to review every tax incentive the state offers. Nonpartisan analysts work with a citizen commission to examine a particular group of incentives each year and make recommendations on whether and how the incentives should change.

• Use solid data and analysis to measure the economic impact of incentives. In Louisiana, businesses benefitting from the state's Enterprise Zone program reported creating a total of 9,000 jobs. But a thorough evaluation by the state's economic-development department found that the new jobs in hotels, restaurants, retail and health care were mostly displacing existing jobs. The agency estimated that the program was netting only 3,000 new jobs and identified a number of ways the incentive could be strengthened, many of which the state adopted.

• Clarify the goals of incentives, then evaluate incentives against those goals. When the North Carolina legislature commissioned a study to assess the effectiveness of the state's tax incentives, policymakers established goals including creating quality jobs, benefiting distressed areas and making the state more economically competitive. Lawmakers and the evaluators identified relevant measures. For instance, they were interested not only in the number of jobs created but also their wage levels, whether they were in industries the state was targeting and whether the businesses were hiring North Carolina residents.

Bright spots like these show that progress is possible in making better use of evidence to determine whether tax incentives are a good investment. As many newspaper editorial boards pointed out in response to the new research, it's now up to policymakers to adopt proven best practices for their own state.

"The important lesson," editorialized the Roanoke Times, "is that spreadsheets and commissions aren't enough. Tough decisions and meaningful policy changes are needed."