JLARC: Discount Incentive Benefits By 90%

Click for larger view. Source: Joint Legislative Audit and Review Commission.

Virginia’s legislative audit agency started its most recent analysis of Virginia’s economic development incentive grant programs with an assumption boosters would quickly dispute – that 90 percent of the economic activity they produce would have happened anyway.

With that assumption baked into the data, the Joint Legislative Audit and Review Commission found very small benefits for the various grants or tax incentives Virginia offers employers for new business locations or expansions.  This year’s summary looked at $1.8 billion spent on grants or foregone through tax exemptions over eight years.

“For grants, the assumption was made that 10 percent of grant employment creation is attributable to the programs, with one exception (the Governor’s Motion Picture Opportunity Fund),” according to the full text of the JLARC report released Monday.  The same 90 percent discount applied to job creation was also applied to capital investments and the tax benefits they produced.  The report cites various academic studies on business location decisions as justification.

JLARC also adds a form of negative dynamic scoring to its calculation, reducing the benefits by presumed adverse impacts of the taxes used to pay for them.  

The state tax revenue generated by the state’s various grant programs was measured at 55 cents for every dollar in grants given by the state.  The payback on various specialized tax incentives was even lower, from three to five cents per dollar, as shown in a slide from the presentation made by Ellen Miller of JLARC’s staff.  The report pegged the overall return at 19 cents of state tax revenue per state dollar cost.

Revenue for the state is not the only outcome sought.  The analysis also showed each $1 million in grants or tax breaks produced 38 jobs, $5.1 million in state gross domestic product, and $3.2 million in personal income, with grants performing the best among major programs.

JLARC worked with the Weldon Cooper Center at the University of Virginia on the economic benefit analysis.  Similar metrics have been applied to individual programs in past analyses, but this was the first use of the methodology across the board.  It provides a contrast to the high pay-off projections the state usually makes about projects receiving grants, such as the recent Amazon project package which will be debated by the 2019 General Assembly.

This JLARC report looks back at the period of 2010 through 2017, so the Amazon project is not yet part of the review.  No one involved with that has indicated that Amazon was 90 percent certain that it was coming to Virginia before any incentives were offered.  As Miller noted in an email after her presentation, the Virginia Economic Development Partnership numbers attribute 100 percent of the outcomes to the incentives.

Some major economic development programs are not included in the analysis because they are relatively new.   The GO Virginia program, managed by a group of business executives, is probably the highest-profile activity not yet subjected to JLARC review, along with a package of future grants designated for Newport News Shipbuilding as it starts construction of a new class of Navy submarine.

Another shipyard grant program, which financed construction of a new Apprentice School, is reported to have cost $32,000 per created job, the most expensive for the period covered by the report.  The headline “cost per job” will be an element in the coming Amazon debate.

Much of the report’s focus is on sales tax exemptions or tax credits offered for specific industries or activities, with JLARC again concluding that in general they do not produce a major revenue return for the state.  The largest tax credit was $82 million paid out over the period for utility usage of Virginia-mined coal, and the largest sales tax exemption was $285 million in tax breaks for data centers.

The report shies away from the major sales tax exemptions which are part of virtually every state’s sales tax system, such as for services or manufacturing inputs.  It focuses instead on those aimed at specific industries or activities, such as shipbuilding, nuclear repair, pollution control, air and rail carriers, railroads and motion pictures.

The exemptions are different than the credits, however.  Some of them have justifications that don’t involve job creation or economic development, such the exemption for pollution control investments.  The entertainment industry incentives deal with companies highly motivated in location choices by tax considerations.  The state’s private ship repair operations would note they compete directly with tax-free Navy shipyards for contracts.

In analyzing the payback on the grants and tax incentives, Weldon Cooper has added another factor seldom mentioned:  It estimated and accounted for “reduction in economic activity because of the tax increase to pay for the sales and use tax exemptions (or grants).”  This is the kind of dynamic scoring of opportunity cost that is rarely used by the state.  In fact, not everybody on the state payroll is willing to admit that raising or lowering taxes has an inverse impact on employment and gross domestic product.

Weldon Cooper estimated jobs added under the grant programs, but then subtracted a number of jobs from each year’s total as jobs lost because other taxpayers had less money.   It also subtracted millions in state gross domestic product and personal income as opportunity costs, lowering the cost-benefit result for grants in general.   The details on all this are buried deep in the appendices.

Click for larger view. Source: JLARC

Lumping all the economic development programs and tax breaks together  in the final table (above), JLARC and Weldon Cooper estimated $74 million in state tax revenues generated during 2017, at a cost of $272 million in grants paid or taxes not collected.  That works out to 26 cents on the dollar, which is a fine return if that is on capital you continue to hold.  In this case, however, somebody else walks off with the principal.

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11 responses to “JLARC: Discount Incentive Benefits By 90%”

  1. LarrytheG Avatar

    Normally I expect JLARD to work with facts not assumptions, audits instead of philosophy and commentary.

    ” … an assumption boosters would quickly dispute – that 90 percent of the economic activity they produce would have happened anyway.”

    well… the real question is WHY JLARC .. uses that ASSUMPTION to start with? What justifies it because it’s certainly not an objective approach…

    So this is a different report – it’s subjective – and it’s subject to challenge from others including economists and so I do wonder the motivation for doing it and the value of doing it if the results are questioned.

    Then we have this: ” In fact, not everybody on the state payroll is willing to admit that raising or lowering taxes has an inverse impact on employment and gross domestic product.”

    not only on the State Payroll but economists and State legislators in Kansas who were sucked in to the idea that if they cut taxes – it would generate MORE tax revenues as a result of increased economic activity than tax revenues lost. – the Laffer Theory.

    What folks don’t seem to understand on this is that when you cut taxes, you’re also cutting jobs – govt jobs – that also put money into the economy.

    Yes.. one can argue that govt jobs are not as productive as private sector jobs that a private sector worker will produce more than a govt worker will but to ignore the fact that when you cut taxes , you also cut that job and in turn it’input into the economy is myopic.

    I’m NOT arguing for more/higher taxes as economic stimulus but I AM saying that when taxes are collected from you and me to pay for a teacher – it’s not money taken out of the economy and put into a black hole.

    A public sector teacher in terms of economic input is no different than a private sector teacher. they both contribute to the economy and the main difference is that money is collected as taxes on one and the other is money voluntarily spent for a teacher. The money works the same on both paths.

    We don’t advocate NO taxes at all on the premise that doing so will get us the absolute best possible economic output and productivity. No one makes that ridiculous argument but they then do something almost as ridiculous by claiming that any money spent on govt services is a drag on the economy.

    1. Well, we can add the “Larry Curve Theory” as the counterpoint to the Laffer Curve. The Larry Curve postulates that higher tax rates produce higher levels of economic growth and social wellbeing. It also provides Larry with the maximum amount of other people’s money to spend.

  2. On a conceptual level, JLARC is absolutely right — any calculation of ROI on economic development grants, tax breaks, incentives, etc. should be dynamically scored. Incentives are routinely scored dynamically already for the purpose of calculating multiplier effects, which inflates the return on investment. But any honest accounting would also account for the “opportunity cost” — the impact of money not spent elsewhere in Virginia’s economy.

    The one thing I find troubling is the assumption, based on national research, that 90% of the economic activity would have occurred anyway. One could argue that Virginia has tighter criteria and controls (despite a couple of high-profile screw-ups) for doling out incentive money. One could argue that incentives play a big role in Virginia nationally for pushing deals over the finish line. I don’t know. The impact of incentives may be unknowable. But it is important to acknowledge, as Steve does in his first paragraph, that JLARC is making a very big assumption.

  3. Certainly some economic development projects would happen without incentives. The difficulty is determining which ones.

    I have only read a small portion of the academic literature that seeks to estimate “but for” percentages. The papers I have seen suggest a wide range of “but for” percentages depending upon the methodology employed and the design of the incentive program(s) being studied. In general, researchers seem to have difficulty estimating “but for” percentages because they don’t have a way of directly determining how a particular incentive (or package of incentives) influenced a particular company location decision. So they are left with a variety of necessarily crude methods to attempt to estimate those percentages.

    The wide variations in the size of incentives offered relative to the project in question (e.g., dollars per job or dollars as a percent of capital investment), eligibility standards (e.g., whether a competitive situation has to exist), and other factors that differ across incentive programs suggest that “but for” percentages vary greatly by program.

    1. Steve Haner Avatar
      Steve Haner

      Hey, don’t tell me, tell JLARC. I was surprised to see this, which is why it became the headline.

      1. “Hey, don’t tell me, tell JLARC. I was surprised to see this, which is why it became the headline.”

        I did. I think the notion of estimating a “but for” percentage by program was outside of the scope of the referenced report. JLARC did do a program-specific estimate for the VJIP incentive in a recent report (“Workforce and Small Business Incentives,” dated July 9, 2018), which suggested a “but for” percentage for that particular program considerably higher than 10%.

      2. Reed Fawell 3rd Avatar
        Reed Fawell 3rd

        There is a limit to analytics. Predicting marriages between specific people, or the lack its consummation between people, and why, is far over the line.

  4. First, thanks to Steve and BR for articles like this. This was never the type of subject covered adequately in mainstream media, and that is even more so today in the era of declining reporting budgets and short attention spans. I would suspect that what Mr. Moret says is likely closest to the truth, but it then doesn’t yield a general “discount factor” or “but for” as he says to evaluate the impact of incentives.

    Amazon is probably a special case. They were probably interested in NOVA based on their internal criteria, but the lack of a responsive incentive package would have signaled lack of interest or perhaps even future opposition to AmazonHQ2. I didn’t follow the debate to closely, but I noticed that there were indicators of opposition in places like Austin.

    Steve mentioned motion picture incentives, and I can say from my time in Los Angeles that there is no doubt many of those project chase the money. Georgia has been a recent favorite. They tend to pick up and leave after the incentive expires. Perhaps some areas, like London, used the incentive to incubate lasting business sectors like graphics, but others, like New Mexico, seem to just end up the equivalent of modern day gold rush ghost towns after expiration of incentives.

    I think the general political reality is there are still many localities that chase these projects, transparency is not as high as it should be on costs, and legislators believe that they can claim victory and move on. In other words, businesses can readily pit them against each other to gain benefit. Against this backdrop, I would say it is then best to focus most on improving the general business climate, while remaining open to specific projects like Amazon, assuring they are done in the most transparent way possible, including base assumptions.

  5. Steve Haner Avatar
    Steve Haner

    This has gotten so far out of hand that there needs to be a federal, repeat federal, response, given this is clearly an interstate commerce-related issue. It should be illegal if not unconstitutional for states to go this far for an individual company. The cost of the incentives is pushed off on others, the cost of funding the government is pushed off on others, and it starts to smack of a taking. I’m not saying VA should unilaterally disarm, but the war needs to end.

    1. “The cost of the incentives is pushed off on others…”

      That would be true only if you assume a particular project would have come without an incentive, or if the state incentive is larger than the net new state tax revenues (after considering additional costs, such as K12 enrollments). I think in most competitive site-selection processes that the incentives do represent a key consideration in the final location decision (i.e., once a firm has identified multiple locations with roughly comparable overall advantages), although state and local economic development folks rarely if ever can know what the exact “but for” threshold is.

      I think the federal policy idea is worthy of discussion, but I think the details would be tough to work out. For example, some states don’t tax M&T at all, while others offer a partial or complete exemption from M&T taxes for a period of time for all new manufacturing investments (whether for new or existing firms). Both approaches treat firms equitably. Would both of those be considered an incentive, or just the second one? If a state or community funds workforce development programs such as welding or computer science to meet a talent need of one or more employers, is that an incentive or just a regular government program? How about development of an industrial park — would states and localities be allowed to purchase land and/or provide public infrastructure (e.g., access roads or rail spurs) to encourage industry development without violating the federal ban?

      These are sincere questions. I’ve thought about the idea of a federal ban on incentives from time to time, and I can never wrap my head around how to make it work in a reasonable fashion. On balance, I think states and localities should be able to make these choices on their own. Multiple polls of Virginians in the last year have suggested support for incentives related to economic development.

      With respect to Amazon, I would make a strong case for the tech-talent pipeline initiatives even if Virginia had not won. Indeed, we were planning to make that case had we lost, because there is such an urgent need to grow those programs to support our entire tech sector. Amazon provided the catalyst for us to make investments that we should have been making anyway.

    2. Reed Fawell 3rd Avatar
      Reed Fawell 3rd

      If you’re a seller or lessor of office space, find the man with the Rolex watch and sell him the building closest to his best imaginable commute, one whose time and distance and locale best inspires and enthralls him. Give him that, and everything else being roughly equal, you’ll win the deal if you know how to make it. Real estate fortunes have been built this way.

      Despite all that, I never seen a such a big deal made without heavy negotiations, including incentives playing a key roll. Great deal makers are demanding. Great deal makers are deeply into every big deal, building its details into machines that work and please, and spin off great benefits for all concerned.

      Incentives make deals work. Incentives distinguish one deal from another, making or breaking them. Incentives are in the warp and woof of every great deal. All big deals and all big deal makers demand respect and best art of the deal. HQ buildings compound and expand this art.

      How to deal with this immutable reality. Build incentives you pay for out of the deal. Build incentives that magnify the power of the deal for all players. Deploy incentives that make a deal hum, and spin, and replicate benefits. A great deal is a tree that gestates an orchard, village, and community round it. It builds and expands on its own power, cumulatively for generations.

      Another complexity with great variables depending on the quality of the deal makers, and the quality of the deal they put together, is measuring the costs inherent in the deal versus the benefits generated by the deal.

      For example, imagine doing a deal with the worlds largest and fastest growing company. A company built on a proven and rapidly expanding base, that is spinning off a host of collateral spin off start up businesses. A company whose energy and power attracts hosts of similar companies into its obit of influence, including its locale. Image the company and its attracted companies employ highly paid, educated workers who tend to marry, have children, stay, and prosper. Here is a K-12 new school a cost of the deal, or benefit? How can building a healthy vibrant community of wives and children not be a benefit? What is a better investment than that?

      We have only begun to understand these dynamics of our modern age.

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