Study: Tax-break incentives for business seldom pay off

Tax breaks are widely promoted by economic development agencies and the business lobby as an effective tool to promote corporate investment. Cities use the offer of tax breaks to lure development - often to prevent neighboring communities from landing the companies with the most potential for creating jobs or sales. The practice is hotly debated, yet despite the controversy public officials appear unlikely to abandon it. An accounting scholar at the W. P. Carey School examined one form of tax incentive - corporate income tax breaks - and found evidence that in fact, the increased investment public officials hope to buy infrequently comes to pass.

It is a mantra repeated early and often by business and civic leaders looking to lure that elusive corporate headquarters or perhaps a major manufacturing plant to the area.

Deeply rooted in history, the seemingly always-urgent call for lawmakers to offer tax breaks to companies for the sake of economic development has for decades been engrained in the mindset of decision-makers. Such moves are considered "no-brainers" as they are wont to say in the halls of government.

But a veteran W. P. Carey School of Business professor begs to differ, backing his contentions with the results from a yearlong, in-depth study. Research by Sanjay Gupta has found that reducing at least one tax really has little if any effect on whether a company decides to pump more dollars into a particular state.

"On the whole, there is no statistically significant effect of cutting the corporate income tax on new capital expenditures," said Gupta, who has been focusing on state and local taxation for about seven years. "The economic effect is very, very small, if at all."

The research, presented in a paper he wrote with Mary Ann Hofmann, a former Arizona State doctoral student, took a fresh look at new investment in the 44 states that had a corporate income tax during a 14-year time span that began in 1983. Excluded were Michigan, Nevada, South Dakota, Texas, Wyoming and Washington.

Hofmann, now an associate accounting professor at Andrews University in Michigan, says the findings were surprising considering the "rhetoric that accompanies these kinds of tax breaks."

"We kind of expected there to be a strong positive relation between more incentives and positive growth, but that just wasn't the case," she said. "We didn't see that at all." Gupta said the research may mean that public policy officials need to make a mental adjustment when it comes to how they think about going after new capital investment. "Maybe we ought to be saying that we should get rid of the exceptions and the incentives and make the broader tax rate lower for everybody," Gupta said.

He said a state's tax structure only is one of a variety of factors weighed by a company when deciding whether or not to locate in a state. The money for incentives may be better spent shoring up other aspects of a state's economy that also are important, such as education, creating a skilled labor force, improving streets and roads and a providing a good transportation system.

He said those ultimately suffering are the businesses that already are up and running in a community, forming the backbone of its economy. "By providing these incentives to new businesses, you are making the playing field uneven for the old businesses and that raises all kinds of questions about fairness," Gupta said.

"Old businesses have the right to say, 'What are we, chopped liver?'"

— Sanjay Gupta, professor of business

Alan McGuire, a longtime economic consultant based in Phoenix, said he has long believed that broad tax relief pays off much more than targeted tax incentives. "It is a much safer bet to lower all taxes and then let the market decide what it wants," said McGuire, whose clients include private corporations and public agencies such as the state legislature. "That's really the way to go in the long term."

The findings come as elected officials in states around the country debate the use of tax breaks and other incentives. States claim they must generate more money because the federal government is passing along more and more costs; cities and towns accuse the states of the same behavior. For example, Arizona lawmakers this session granted big corporate income tax breaks to manufacturers with multi-state locations in a specific attempt to convince Intel Corp. to expand its operations in the state. Oregon and New Mexico also are vying for a new Intel plant.

But recently, the mayors of three of three of the state's largest cities — Phoenix, Tempe and Chandler — agreed not to use tax incentives and subsidies to attract retail development in the area where they share boundaries. The 25-square-mile stretch along Interstate 10 would become an "incentive-free zone."

"It's time for cities to stop competing against each other and, instead, to start partnering in competition against other regions in the country and the world," Phoenix Mayor Phil Gordon said. Officials said the hope is for other cities and towns in the metropolitan area to join the effort and sign similar agreements in the not-too-distant future, discouraging developers from shopping a project around to get the best perks.

If not, state Sen. Ken Cheuvront, D-Phoenix, has said he is prepared to move ahead with a bill that proposes an all-out ban on such tax breaks by municipalities. It is one of several bills designed to put pressure on city giveaways.

And Arizona is not alone. Similar debates pro and con are being waged across the country as states grapple with each other for new companies and the dollars attached.

Hofmann said she believes there are no real winners in these high-stakes bidding wars and that places need to take a step back and look at the bigger picture. "This whole tax competition among states is a game where everyone really loses - it's like a race to the bottom," she said. "If you follow it to its logical conclusion, all states would do away with corporate income tax. And that just makes no sense."

Neither is the debate new. Gupta, who began studying state and local taxes during a 1998 sabbatical at the University of California at Davis and University of Southern California, says the avalanche of incentives can be traced to a time decades ago. That was when Japanese automakers were trying to set up plants in the U.S. and states like Alabama and Tennessee were eager to have them and willing to pay for the opportunity.

Gupta said he has made several presentations on the study to tax groups and now is trying to determine how cutting the corporate income tax affects a state's revenues. That paper is expected to be released in about three months.

But he does not expect any widespread changes to result from his findings — at least not in the near future. "My gut feeling is that incentives are probably too deeply embedded at this point for anything to change," Gupta said. "It's just a very popular thing to do these days."