What is an economic development incentive?

One in a series explaining key terms and concepts of Pennsylvania government. Today’s topic: economic development incentive

Seeking a better understanding of Pennsylvania’s issues and proposed solutions? Sometimes, complicated jargon and concepts can get in the way. That’s why we started Explainers, a series that tries to lay out key facts, clarify concepts and demystify jargon. Today’s topic: economic development incentives. Last updated 10/28/14

What is an economic development incentive?

It’s a tool state and local governments use to spur business growth in underdeveloped neighborhoods and post-industrial cities. These areas often have high unemployment rates, low income levels, high crime, and abandoned buildings — all disincentives to investment.

Incentives can take many forms, including cash rewards and loans; free buildings; infrastructure improvements; tax breaks and credits; and job training programs.

Pennsylvania spends at least $4.84 billion per year on incentive programs, according to a 2012 analysis by the New York Times. Most of its incentives are tax credits, rebates or reductions. (Update 10/28/14: Experts disagree about what qualifies as an economic development incentive, so other groups have come up with significantly different estimates. For example, the Keystone Research Center, a left-leaning policy development organization, says Pennsylvania spends about $500 million on economic development incentives per year.)

Cities and states offer incentives because they have problems that make them unattractive to businesses. In Pennsylvania, besides the urban woes cited above, those factors include high corporate tax and property tax rates; an older, less educated work force; and influential labor unions.

As an example, a state might give a tax credit to a business for choosing to locate its headquarters in a particular city. In exchange, the company may agree to hire locals. In an ideal world, the firm’s current employees will also live, work, shop, and pay taxes in the area.

In reality, that doesn’t always happen. Sometimes a company will move its headquarters across state boundaries — say, from a riverside New Jersey town to Philadelphia — to take advantage of a tax break. If the firm’s workers stay where they lived before, the relocation may do little to stir up business in the new city. Especially if the employees drive to work in their cars, eat at their desks, and head straight home at 5 p.m.

That’s one reason some economists and local development officials criticize certain incentive programs. Those people say incentives can create bidding wars between states and cost more money than they bring in. Critics also argue that incentives waste taxpayer dollars on companies, such as hotels or iconic sports teams, that would have moved to or stayed in a city anyway.

Do economic investment incentives usually work?

States, including Pennsylvania, rarely track the effectiveness of their incentives.

In a 2007 report on a now-defunct incentive called the Opportunity Grant Program, the Pennsylvania Auditor General’s office found that the state Department of Community and Economic Development didn’t follow up with companies until three years after giving them a grant.

That meant it was unaware that several of its grantees went out of business after receiving the funding, but before the three-year mark arrived. After the companies shut down, it was difficult to get the state’s money back. The Department also used companies’ self-reported information — which could be incomplete or inaccurate — to measure the success of incentives.

Most of Pennsylvania’s incentive programs include provisions that allow the government to take back tax revenue or funding if a company doesn’t hold up its end of the bargain. These are known as “clawback” provisions. The state doesn’t always use them.

For instance, over 11 years, DCED waived more than $49 million in penalties it could have collected from companies that didn’t fulfill their contracts under the state’s Opportunity Grant Program. DCED didn’t have any specific guidelines for when it should go after companies for that money, and it didn’t document the reasons it waived the penalties.

Update 7/23/14: DCED says it is still pursuing clawbacks from certain companies that didn’t fulfill their obligations under the Opportunity Grant Program. The Department has requested $7 million in clawbacks over the last three years and it has received about $5 million so far. A spokesperson says DCED hasn’t waived any penalities for grants awarded from fiscal years 2007 to 2010.

In 2009, the state’s Legislative Budget and Finance Committee looked at another program, the Keystone Opportunity Zone. The program lowers state and local taxes for individuals or businesses that develop land in one of 12 designated zones.

The report was scathing. It found that KOZ program records are “poorly organized and incomplete,” and that DCED doesn’t monitor the type of business activities or number of jobs companies generate. The committee also found that many companies weren’t creating jobs or luring new investment capital, and the program didn’t require them to.

Update 7/23/14: DCED has changed the KOZ program since the report. Now, a company that relocates to a KOZ must increase its full-time employment by 20 percent within its first full year of operation or invest 10 percent of the prior year’s gross revenues in the property. There’s no rule saying employees have to live in Pennsylvania. The Department also now monitors the number of jobs a company has created and retained.

The office of current Auditor General Eugene DePasquale is working on another audit of the state’s economic development incentive programs, to be released this year.

Did this article answer all your questions about economic development incentives? If not, you can reach Marielle Segarra via email at msegarra@whyy.org or through social media @mariellesegarra. Have a topic on which you’d like us to do an Explainer? Let us know in the comment section below, or via Twitter @Pacrossroads.