The structure and realizability of economic incentive programs are some of the more elusive components of the site selection process because economic incentive programs can vary significantly from state to state, and even among neighboring cities. Each jurisdiction has its own economic development goals and not all those goals are alike. Regardless of communities’ objectives, the structure of their economic incentive programs is important because during the site selection process a company needs to accurately quantify these benefits to estimate the return on investment and viability of a project; moreover, once a location is chosen, a company must ultimately forecast the value of these benefits into their long-term financial planning. This blog focuses on the broad categories of economic incentives and how they are incorporated into a company’s site selection decision.
Economic incentive types
One of the most basic distinctions between economic incentive programs is whether they are considered statutory, quasi-statutory or discretionary. If a company is guaranteed an incentive based on meeting requirements delineated in statute, then the program is considered statutory. A quasi-statutory incentive has the same characteristics of a statutory incentive but requires pre-application or pre-approval before a company can benefit from the program. Discretionary incentives, sometimes called negotiated incentives, are not granted based purely on satisfying statutory requirements but hinge on the offer and approval of such benefits by the subject state, city, county, utility, etc.
Here’s a look at the primary advantages and disadvantages associated with the two primary economic incentive types:
Incorporating different types of economic incentives into the site selection process
Some more commonly utilized state statutory incentives are the sales tax exemption for manufacturing machinery and equipment, freeport exemptions from property tax on inventory and research and development tax credits. These credits can be quantified early in the site selection process and incorporated into a company’s financial model as they compare a set of finalist locations. For example, if a company is considering an investment of $20 million in machinery and equipment related to manufacturing in either Texas or Alabama, it can estimate the potential state and local sales tax imposed in each jurisdiction. Since Texas has a statutory sales tax exemption for such equipment and Alabama does not, then a company can model an incremental sales tax liability of $400,000 in Alabama, assuming a combined state and local rate of 2%.
Common discretionary incentives include cash grants, property tax abatements, payroll rebates and some income tax credits. These are harder to quantify at the outset of the site selection process because they are typically not fully negotiated and secured until later in the process and are generally based on actual performance. For example, property tax abatement terms can vary significantly among jurisdictions and can either be full abatements, scaled abatements and for any duration such as three years, five years or up to 20 years. Moreover, these benefits are impacted by the actual investment made, the timing of the investment, annual property tax rates, assessed valuations and depreciation methods. Site Selection Group assists companies in conservatively quantifying these potential benefits based on prior project experience and publicly reported project comparables.
Quasi-statutory incentives fall in the middle of statutory and discretionary economic incentives in terms of being able to quantify such benefits. Oftentimes the benefits associated with such programs are easier to estimate at the outset of a project, like statutory benefits, but there is risk that a company may not ultimately qualify for a variety of reasons. Thus, it is best to conservatively include these benefits based on the probability of success or perhaps to exclude them so as not to skew the results of a comprehensive financial model.
Each project has its own unique characteristics, as does every jurisdiction and each of its incentive programs. Inaccurately estimating or dissimilarly valuing economic incentives can significantly alter the overall financial model and result in a bad site decision. Thus, when and how to incorporate estimated benefits associated with various economic incentive types into the site selection process should be made prudently and on a case-by-case basis.