Utilizing Economic Incentive Strategies to Create a Diversified Economy

The most successful and thriving state economy is one that has a highly diversified industry base to buffer the effects of cyclical downturns in specific industry sectors. The ability of a state or region to diversify their industry mix is often dictated by its natural and human resources. The Midwest has agriculture, Silicon Valley has technology, New York City has financial services, Washington has government, Boston has biotech and Texas has oil and gas. All of these regions, states and metro areas mentioned have faced major challenges in the past when the dominate industry has suffered. How can you protect an economy from the down cycle of a dominate industry? One possible answer is economic incentives. Using economic incentives to create a diversified economy is a proven technique to building a long-term stable economy. 

How can economic incentives help diversify an economy?

So how does a state or local community attract more varied industries?  This is where the use of economic incentives can truly make a difference. While economic incentives are rarely, if ever, the primary factor in site selection, this is how they can bridge the gap in recruiting business which might not otherwise consider a particular location. For instance, if the only economic incentive available is targeted toward attracting large capital investment, then it will not entice non-manufacturing or industrial projects. Such an incentive ignores projects and industries which are more labor intensive or provide higher wage rates.

Conversely, the inability to provide property tax abatements, perhaps via a state constitution, hampers a community’s ability to help offset the substantial costs associated with opening and operating a facility. When this type of benefit is not even available to reduce costs associated with business personal property investments, a jurisdiction cannot compete with states that statutorily exempt such property from taxation.

Income tax credits need to be refundable, transferable or saleable

One particular credit that seems to do very little in the sense of encouraging investment, is the income tax credit. This is true whether it comes in the form of a job tax credit or an investment tax credit because most states have moved away from the three-factor apportionment formula that used property, payroll and sales to calculate a business’s pro-rata share of taxable income.

Now most states are only using a single sales factor approach which results in only taxing income attributable to sales made to customers in the state. This formula does not penalize companies for having a presence in the state by maintaining property or employees. Due to this one major tax reform, as well as many states lowering corporate income tax rates, any credit used to offset state income tax is not very appealing.  As a result, some states have made their income tax credits refundable, transferable or saleable. 

Payroll rebates, sales tax rebates and training subsidies can help attract companies

In addition to enhancing the features of the traditional income tax credits, state and local jurisdictions are continuing to add tools to their proverbial economic development toolkit. Payroll rebates continue to grow in popularity, especially since they are tied to company performance.  Sales tax rebates encourage a business to make capital investments without being subject to the additional cost of sales tax such as that on construction materials.

Training is another economic incentive which can be structured in a multitude of ways. A true state and local partner in training — and perhaps subsidizing — a company’s workforce is invaluable to the long-term success of a company’s operation.

Texas is a prime example of economic diversification through economic incentives

Texas is a state that learned from the past that diversification of industry was essential to long-term growth and success. The Texas case study goes back to the 1980’s when the price of oil, which had peaked in 1980 at over $35 per barrel (equivalent to $101 per barrel today when adjusted for inflation), fell in 1986 from $27 to below $10 (or from $58 to $22 today).

This dramatic shift in oil prices is almost identical to the current challenges faced by the oil and gas industry; however, Texas implemented an aggressive economic development strategy stimulated by economic incentives to create a highly diversified industry base that protected Texas’ economy during this most recent challenging time. This diversification is evidenced by Texas Comptroller data, indicating the share of Texas’ revenue from oil and gas production taxes went from 17.7% in 1982 to 5.5% in 2014.  

It doesn’t hurt that Texas has 8% of the U.S. population and created a reported one-third of new private sector jobs in the U.S. since 2000. These jobs were created in industry sectors such as advanced technology and manufacturing, aerospace and aviation, defense, biotechnology/life sciences and information and computer technology. So how did Texas do it? 

The Texas Enterprise Fund, established in 2003 with an initial $295 million investment, was one of the main tools. The fund has become one of the most competitive economic incentive recruitment tools in the country and yielded up to $6.3 billion in capital investment in Texas by out-of-state companies.

Some of the major projects awarded grants from the Texas Enterprise Fund include Apple (3,600 jobs), Toyota (3,650 jobs), JPMorgan Chase (4,200 jobs), Bank of America (3,876 jobs), Rackspace (4,000 jobs), Caterpillar (1,714 jobs), Medtronic (1,384 jobs) and Triumph Aerospace (3,000 jobs). In addition to the state’s ability to offer cash grants via the Texas Enterprise Fund, cities and counties are perhaps even more aggressive. Depending on the location, a city and county can provide their own cash grants, property tax abatements, sales tax rebates, free or reduced real estate costs. This combination of economic incentive programs at a state and local level has truly made Texas successful in attracting varied industries.

Conclusions

Every company will have its own unique set of issues and hurdles to overcome in the site selection process. Many of these obstacles can be addressed by state and local governments that have the ability to be flexible and creative in utilizing a diverse array of economic development programs. Economic incentives are one tool that economic development organizations across the U.S. can use to diversify their economy; however, it is critical to evaluate every project carefully to make sure the investment in a company matches the long-term diversification strategies of the community.