Offering property tax incentives to lure businesses to locate in cities and towns is a common practice, costing state and local governments up to $10 billion annually in forgone revenue. Boston recently used tax breaks to promote continued growth in the Seaport district. But there's a major problem. There is little evidence that this practice has much of an effect, either in the decision-making process or in terms of promised economic activity or new jobs.
So say Lincoln Institute researchers Daphne Kenyon and Adam Langley in Rethinking Property Tax Incentives for Business, our latest Policy Focus Report. The policy deserves closer scrutiny because there is so much money at stake and so little evidence of impact, they say. They found that property tax incentives are unlikely to have a significant impact on a firm’s profitability, since property taxes are a small part of the total costs for most businesses—averaging much less than 1 percent of total costs for the U.S. manufacturing sector; that tax breaks are sometimes given to businesses that would have chosen the same location even without the incentives -- thus merely depleting the tax base without promoting economic development; and that widespread use of incentives within a metropolitan area reduces their effectiveness, because when firms can obtain similar tax breaks in most jurisdictions, incentives are less likely to affect business location decisions.
Over the course of nearly two years, Kenyon and Langley, authors of the report Payments in Lieu of Taxes: Balancing Municipal and Nonprofit Interests, analyzed five types of property tax incentives and examined their characteristics, costs, and effectiveness: property tax abatement programs; tax increment finance; enterprise zones; firm-specific property tax incentives; and property tax exemptions in connection with issuance of industrial development bonds.
The goal of promoting economic development is laudable. Attracting new businesses to a jurisdiction can increase income or employment, expand the tax base, and revitalize distressed urban areas. In a best case scenario, attracting a large facility can increase worker productivity and draw related firms to the area, creating a positive feedback loop.
But municipalities should first consider alternatives to property tax incentives to achieve these economic development goals, the report says, such as customized job training, labor market intermediaries, and business support services. In addition, state and local governments also can pursue a policy of broad-based taxes with low tax rates or adopt split-rate property taxation with lower taxes on buildings than land.
If property tax incentives continue to be used as part of the economic development toolkit, the report recommends that they be fine-tuned and more closely scrutinized. State government can restrict the use of incentives to certain geographic areas or certain types of facilities; publish information on the use of property tax incentives; conduct studies on their effectiveness; and reduce destructive local tax competition by not reimbursing local governments for revenue they forgo when they award property tax incentives.
Local government officials should set clear standards for avoiding the use of incentives when costs exceed benefits. Localities should set clear criteria for the types of projects eligible for incentives; limit tax breaks to mobile facilities that export goods or services out of the region; involve tax administrators and other stakeholders in decisions to grant incentives; cooperate on economic development with other jurisdictions in the area; and be clear from the outset that not all businesses that ask for an incentive will receive one.
The findings were summarized in an op-ed essay in The Boston Globe, published earlier this week. The report is available for free downloading here.