My latest is in the Pioneer Press and reprinted below.
For the last 25 or so years the City of Saint Paul has used a variety of tax incentives to encourage business location decisions and encourage economic development. Are they necessary? The simple answer is no, and there are far more effective tools than tax breaks to to encourage business development.
Perhaps at the top of any list of political myths is the idea that taxes, including their incidences and incentives, are serious factors affecting business relocation decisions. At the core of this belief is the idea that businesses make decisions about where to locate a facility based primarily, or perhaps even exclusively, upon taxes. As a result of this belief, state and local governments have engaged in dramatic tax wars against one another to lure businesses to their community.
What do we really know about the impact of taxes upon business relocation decisions?
The literature is clear — tax breaks to encourage economic relocation are economically inefficient and wasteful.
Social entreprenteur Michael Kieschnick reviews numerous studies and methodologies examining the role of tax incentives on business location decisions. He concludes: “Even though there were considerable variations in the specific questions asked, the types of firms in the sample, and the areas in the country, taxes and financial inducements were consistently ranked in the bottom one-fifth or one-tenth of factors mentioned by respondents.”
Economist Michael Wasylenko in his State Tax Notes survey of more than 100 studies on the impact of taxes on business location decisions finds little evidence that the level of state and local taxation figures prominently in business location decisions. State and local tax incentives and financial inducements are not the only or even the primary influences on business location decisions.
Still other studies by economists reach a similar conclusion. Roger Schmenner notes how economists see taxes as having minimal impact on business location decisions, even though economic development practitioners and elected officials disregard his evidence. Timothy Bartik reviewed 84 econometric studies undertaken since 1979 examining the role of tax incentives, generally finding that taxes across regions had little impact on location decisions.
In “Money for Something: Job Creation and Job Quality Standards in State Economic Development Subsidy Programs,” the authors examined 238 state economic development programs across the 50 states and the District of Columbia. The analysis looked at a range of economic incentives that included tax cuts, subsidies, tax incentives, loans and several other inducements, including Tax Increment Financing (TIF) districts and enterprise zones. They similarly found these tax incentives have little impact on business location decisions.
When businesses are surveyed regarding factors important to their economic location and relocation, taxes often come in way behind proximity to markets, suppliers, labor costs and the quality of the labor force. Former University of Minnesota professor Ann Markusen found that quality of life and the arts are also critical factors driving economic development.
None of these conclusions should come as a surprise. Many of these other factors occupy a larger percentage of a business’ budget than do taxes, and all of them are far more critical to the long-term success of a business than are taxes. Moreover, when pressed, businesses will actually admit to this in public. For example, nearly 62% of those interviewed in a California study on hiring tax credits indicated that the tax credits had never or rarely affected their decision to hire individuals. In the same study, nearly half of those interviewed stated that tax incentives for relocation did not affect their decisions.
Overall, the economic development literature states that tax incentives and levels of taxation are not major determinants of relocation, but instead might have some marginal influence in terms of a small choice between sites in areas not far apart.
The argument here is not that taxes do not matter. Instead, they matter but at a lower order or in more subtle ways than chamber-of-commerce-types of arguments would suggest.
First, when decisions regarding location are being made, other factors rank higher, such as labor costs or access to markets and suppliers. This is what businesses will first consider when making more macro or first-cut decisions regarding where to locate. Once these major factors are considered, then taxes become a secondary or tertiary factor to narrow down more specific locations or jurisdictions in which to settle.
Thus, when a business adds up all of the costs and factors affecting where it should do business, there may be only a handful of places that make sense for a business to relocate to. Here is the point where businesses then pit communities against one another seeking to extract cut taxes in a bidding war that pits cities or states against one another.
In sum, tax cuts have a marginal impact on business location decisions. They also serve to shift tax burdens to other home owners or residents. Rarely do the supposed jobs produced by the business relocation pay for themselves.
If cities such as St. Paul do wish to encourage business relocation and economic development, they are better spending their money on quality schools, workforce training, infrastructure and perhaps other public safety and services to improve the quality of life in a community.
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