The Nuanced New World of Economic Development Incentives

Beyond the black-and-white debates of the past, local governments are taking strengths, weaknesses and social equity into account.
May 1, 2017
By Christiana K. McFarland  |  Contributor
Research director for the National League of Cities

With high-profile local-government economic development deals making headlines and the availability of new transparency data on public giveaways, the tax-incentive debate is in the spotlight in a serious way. The arguments are familiar ones: On one side are those who label incentives as corporate welfare in which cities indiscriminately and unnecessarily fork over public dollars to lure potential jobs. On the other side are businesses claiming to need incentives to make deals pencil out and cities convinced that they must meet business demands to secure future growth.

But is the use of incentives really this black and white? Like most things, the truth lies somewhere in the middle. What is lacking, though, is an updated and grounded understanding that goes beyond buzzwords and mudslinging. Digging into local nuances reveals a more complex approach for how, when and why some cities use incentives that others can learn from.

Take Washington, D.C.'s LivingSocial deal, for example. In 2012, the daily-deals company was offered $32.5 million in tax breaks to jump-start a technology ecosystem in the District. But the high hopes for LivingSocial, and its job-creation prospects, were dashed as the company lost ground to its competitor Groupon.

The District took a lot of flack for making the deal, but in the end LivingSocial did not collect incentives. This is because the agreement included community safeguards, including creating jobs before receiving incentives. And although the company failed to deliver jobs, it did help spur a local startup culture in a town best known for politics.

The LivingSocial story sheds light on how many cities, not just D.C., are advancing the practice of economic development. Done right, cities disavow smokestack chasing, start with strategy, commit to data, protect taxpayers and bring meaningful change to the community.

Across the Potomac River in Arlington County, Va., Economic Development Director Victor Hoskins (formerly D.C.'s deputy mayor for economic development) views the debate about incentives as too narrow. "Economic development starts with a strategy that determines how resources are allocated to yield a return for the public good," Hoskins says. "Sometimes this includes incentives, sometimes not."

Arlington boasts a well-educated workforce, a low unemployment rate, a high concentration of millennials, great schools and a strong transit network. On paper, the urban county has one of the nation's strongest local economies, so why would it even consider using economic-development incentives?

As Hoskins points out, "Knowing liabilities is just as important as leveraging your assets." A deeper look at Arlington's economy reveals a heavy reliance on a single and sometimes unpredictable employer -- the federal government, whose employees make up about a quarter of its labor force -- along with some troubling commercial real-estate trends. Case in point: The county is experiencing record-high office vacancies, upward of 22 percent in recent years, as a result of federal relocations and office-space efficiencies.

Factors like these inform Arlington's incentive strategy, which prioritizes projects that diversify its economy and improve occupancy rates, such as the recent Nestlé deal. A collaboration among the county, the state and the owner of an office building that had sat vacant since its completion in 2013, the $16 million incentive deal occupied the building with 750 non-federal jobs.

As Arlington's example illustrates, a community's market strengths and weaknesses are critical to determining its approach to incentives. As noted in the National League of Cities' new economic development policy guide, produced in partnership with the International Economic Development Council, strong- and weak-market cities demand different types of strategies and considerations. In cities with weak real-estate markets, for example, the use of incentives such as tax breaks and fast-tracked approvals is often necessary to secure deals and attract outside investment. Amenities such as talent and affordable housing are particularly vital to business attraction and retention.

In Rust Belt cities hit hard with job losses and foreclosures, there is a general sentiment that projects can rarely, if ever, get done without incentives. In Cleveland, for example, rents are a little more than half those in Chicago, yet construction costs are the same or higher. This means that commercial developers can make more money in other locations.

To help level the playing field with stronger market cities, Cleveland uses a very targeted approach to help to change the economic calculus for developers. In addition to fiscal impact analyses, performance measures and clawbacks, "we assess and help fill the gap between a return on investment to the developer -- that is still far below that in strong markets -- and their ability to attract capital to the project," says Tracey Nichols, the city's former director of economic development, now with Project Management Consultants.

To ensure that these projects benefit all members of the Cleveland community, the city also has a robust Community Benefits Agreement that requires contractors to hire local construction workers and to use minority, female and small-business subcontractors while encouraging developers to provide internships and other opportunities to Cleveland students. Additionally, school revenues are protected in any discussion of tax incentives.

On the flip side are some strong-market cities that are rebalancing the role of incentives after, ironically, becoming victims of their own success. Charlotte, N.C.'s incentives program stimulated robust growth of Fortune 500 and other large firms, but it concentrated wealth and did not expand economic opportunities to local residents and small businesses.

Charlotte's wakeup call came when it was bestowed the not-so-coveted honor of ranking dead last in the economic mobility index created by economist Raj Chetty. "A rising tide is not lifting all boats," says Kevin Dick, Charlotte's economic development director. "Our policymakers are actively considering alternatives within incentive agreements that more intentionally address local hiring and contracting with local small businesses, including those owned and operated by people of color and women."

The city recently took a big step forward when it launched its Economic Opportunity Task Force and became an inaugural participant in the Equitable Economic Development Fellowship led by the National League of Cities, the Urban Land Institute and PolicyLink.

What the stories of D.C., Arlington, Cleveland and even Charlotte offer is not a precise recipe for success but a glimpse into how communities can adapt to a rapidly changing economic environment. To be sure, many governments still take an antiquated approach to incentives --offering them to just about any company promising to bring jobs -- that has been found to miss the mark tremendously.

The reality is that as long as there is competition there will be incentives. Recognizing this, while shining light on those that are carefully tailoring their incentives strategies to unique local circumstances, is what is needed to advance the practice of economic development.