Is There a Better Way for Cities to Lure in Businesses?

Now that Amazon's HQ2 search is finally over, people are once again calling for reforms to economic incentive packages.
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An Amazon office in Lauwin-Planque, France.

Amazon's decision to split its HQ2 second headquarters between Queens, New York, and Arlington, Virginia, revived an ongoing debate about the benefits of city-sponsored incentive packages.

When Amazon announced last week that it would split its HQ2 second headquarters between Queens, New York, and Arlington, Virginia, the decision was immediately met with a good deal of unease and protest, particularly among residents of smaller cities who had been hoping for a transformative new corporate resident. Further, Amazon had to work to deflate allegations that its highly publicized search for a host city had been a ruse designed merely to collect information and secure lucrative tax breaks from two target cities.

Amazon's decision also revived an ongoing debate about the benefits of such city-sponsored incentive packages. After all, economists have frequently found incentive programs to bear limited effects on both job creation and companies' location decisions.

And while critics blame such deals for draining state coffers and forcing cuts to social services like education, politicians from both parties nonetheless continue to participate in such bidding wars, conscious of the fact that voters reward lawmakers for bringing companies to their backyards.

In response to these criticisms, economists and policymakers have begun proposing strategies to reform the broken process. Last year, former Delaware Governor Jack Markell argued in an op-ed in the New York Times that Congress should impose a 100 percent federal tax on state or local incentives given to specific companies. Investments in infrastructure and workforce development, as well as state policies designed to attract certain types of business (small businesses or high-tech firms, for example), would still be permitted under Markell's proposal.

Such a change, Markell writes, would mean that "states and municipalities would invest in and compete solely based on factors that make the most difference for an area's economic potential and for a company's ultimate success, like the abilities of the work force, the excellence of their schools and the quality of life for residents."

Writing on Twitter shortly after Amazon's announcement last week, economist Tim Bartik of the Upjohn Institute, who has studied incentive packages intensively, suggested some modifications to Markell's proposal. Namely, limiting the 100 percent tax to only the very largest corporations and only incentives that last longer than five years and exceed some threshold (as a percentage of the wage bill for the new facility).

It is, of course, difficult to imagine many of these reform proposals making it through Congress. "Hard to imagine a Presidential candidate of either party having to make stump speeches in Wisconsin, Texas, South Carolina, New Jersey, Michigan, Ohio, Indiana, and, of course, New York and Virginia talking about how bad incentives are," says Nathan Jensen, a professor at the University of Texas–Austin who has studied the political benefits of successful incentive packages. "I think the limitation is finding the political will to push for these given it could really alienate many state politicians."

Another new proposal for reform, however, may have better luck. In a brief published by the Hamilton Project earlier this year, Duke University economist Aaron Chatterji proposed the establishment of a federal Main Street Fund that would incentivize states to spend money on evidence-based programs and initiatives that "foster a competitive environment for all businesses" instead of big firm-specific incentives directed to large corporations. Under Chatterji's proposal, states would have their funding reduced if they offered new firm-specific incentives and increased if they canceled existing deals.

Chatterji's proposal is motivated in part by an often-overlooked reality: firm-specific incentives, in addition to being a potentially inefficient and economically damaging policy, are increasing the barriers to entry for young, fast-growing start-up firms, potentially contributing to increased market power for large incumbent firms and a decline in dynamism in the United States. As Chatterji details in his brief, 20 percent of total U.S. job creation comes from start-ups; half of all jobs created in the U.S. are created by its fastest-growing firms (those with employment growth greater than 25 percent). Yet these smaller firms receive far less government support than large incumbents.

Chatterji identifies four types of programs with demonstrated effectiveness and benefits for these young, high-growth firms: management training, enhanced reciprocity for licensed workers, investments in broadband infrastructure, and targeted initiatives for firms with high growth potential.

"What I love about [Chatterji's proposal] is that it gives small businesses and their supporters more reason to be involved in these incentive discussions," says Jensen, who has co-authored work with Chatterji in the past. "My experience is that a hearing on incentives at the state level is packed with companies, developers, and industry groups all pushing for more."

For his part, Jensen has a few modest proposals for reforming the process: impose caps on incentives, require every incentive to be included in the state or locality's budget (for the sake of transparency), and limit incentives to five years in duration.

"These aren't very exciting, but I think they are plausible at the state level and would save a ton of taxpayer money," Jensen says.

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