Tax Incentives Only Part of Picture for State Business Climates

States each year dole out billions in incentives and tax breaks for businesses, but those that spend the most aren't necessarily winning the end game, some experts say.
by | January 4, 2013 AT 12:00 PM

States each year dole out a collective $80 billion in incentives and tax breaks for businesses they hope to lure or keep within their borders. But those that spend the most on incentives aren’t necessarily winning the end game, some experts say.

States that put the most stock in handouts to businesses don’t always earn high scores for being business friendly, a Governing analysis of data on tax incentives and business reputation has shown. Texas spends 51 cents of every budgeted dollar on incentives, according to a New York Times database, but still rates as average in Moodys' Cost of Doing Business Index. Meanwhile Iowa spends 4 cents on the dollar but rates in the top 10 in Moodys’ index, thanks to cheaper labor and energy costs.

Other states like Nebraska, Oklahoma and West Virginia, all spend more than one-third of every dollar on incentives and succeed in having business friendly reputations. But the reality, experts say, is that tax incentives are only a piece of the puzzle when it comes to attracting – and keeping – businesses. And they often don’t come with any guarantees for states.

“I’m not sure that giving tax incentives is the way to create growth in a state,” Scott Drenkard, an economist with the Tax Foundation, told Governing. “It certainly lowers the cost of doing business – but at what cost [to taxpayers]?”

That question, Drenkard admits, is hard to answer. But there are more tangible issues states should consider before offering up money to woo businesses, he says. For one, leaders should weigh the “opportunity cost,” or what they’re giving up for all businesses by giving away millions to one company. In other words, are states giving up the opportunity to lower tax rates for all businesses instead of just one?

Chris Lafakis, a Moodys analyst who helped compile the Cost of Doing Business Index, notes that incentives can also compromise economic growth.

“That’s more open to interpretation,” he says. “I think definitely it helps but maybe some of those companies would have invested in Texas anyway.”

And on the flip side, incentives tend to draw more mobile firms so if the cash dries up in one state, that company can move on to their next best offer.

Dozens of companies have scored more than $100 million in incentives and tax breaks over the last five years, according to the Times database. Chief among those is Internet retailer, which has been awarded at least $348 million from 22 grants in nine states, the database says. The award includes a $277 million handout from Texas in the form of property tax abatement, a sales tax sharing agreement and other discounts. None of the incentives, however, have come from Washington, where Amazon is headquartered.

And in 2010, Northrop Grumman became the second Southern California company to be wooed to Northern Virginia with a tax incentives and grants package from the state. It followed Hilton Hotel Corp., which moved from the Los Angeles area to Fairfax County in 2009.

But some states don’t rely heavily on incentives and still have a good business climate. North Dakota spends just 1 cent of every budgeted dollar on incentives but ranks third in Moodys’ index. Its business tax climate rates in the middle of states, according to the Tax Foundation, but North Dakota’s extremely low energy makes it affordable for business.

Energy costs, says Lafakis, play a big factor in business location and they are typically linked with geography so states don’t have much wiggle room when it comes to changing those costs. States like California have more expensive electricity while Hawaii depends a lot on fuel oil to generate power. But other states are luckier.

“Hydroelectric power is the one reason Boeing settled in Washington in the first place,” Lafakis says. “Coal is all over the Midwest so a lot of auto companies set up shop in Detroit, Ohio and Indiana.”

And then, despite all the strikes against them on paper, some states just have the “it” factor.

“Weather matters for sure,” Drenkard says. “There’s companies that want to be in California and they have a pretty rough fiscal structure.”

New York, he adds, scores 50th on the foundation’s index but thanks to Wall Street it isn’t struggling to attract business.

In the end, the rate at which states offer more incentives often speaks more to that state’s ideology rather than its actual standing in the business community.

“There are some states that are more disposed, that just feel more than others [that] providing tax incentives is a better economic policy,” Lafakis says.

Take Alabama, for example. Even without offering too much in the way of incentives, the state’s already low tax burden should make it a draw – if taxes were all that mattered.

“It has the fifth-lowest tax burden and it has trailed Texas measurably,” Lafakis says. “That shows more to economic growth than having a low tax burden and providing these incentives.”