IN TRYING TO maintain momentum in the Innovation District in the South Boston Waterfront, Boston has dangled millions of dollars in tax breaks in front of companies settling there. It was hardly a radical gesture in the world of economic development. The policy has become so common over the last 50 years that state and local governments across the country are routinely forgoing up to $10 billion in revenue every year.
However, there is little evidence that property tax incentives actually work — either in the decision-making process for companies choosing their locations, or in terms of promised economic activity or new jobs.
Our research, published this week by the Lincoln Institute of Land Policy, identified three obstacles that impede the success of property tax incentives as an economic development tool. First, 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 less than 1 percent of total costs for the US manufacturing sector.
Second, tax breaks are sometimes given to businesses that would have chosen the same location even without the incentives. When this happens, the incentives merely deplete the tax base without promoting economic development.
Finally, widespread use of incentives within a metropolitan area reduces their effectiveness, because when firms can obtain similar tax breaks in most jurisdictions, incentives are even less likely to affect business location decisions.
Yet the use of these tax incentives continues to reflect the triumph of hope over experience. Across the country, municipalities are using a variety of programs that are widely accepted as absolutely necessary elements of the economic development toolkit: 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.
It’s not that the goal is not laudable. Attracting new businesses can increase an area’s income and 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.
If municipalities insist on continuing to use tax incentives to make that happen, they could at least use them more surgically. Local government officials should set clear criteria for the types of projects eligible for incentives, and draw the line when costs exceed benefits; 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.
There are also plenty of other ways to attract business: customized job training, labor market intermediaries, and business support services are some effective alternatives. Instead of selectively granting incentives, state and local governments can improve the tax climate through a policy of broad-based taxes with low tax rates or adoption of split-rate property taxation with lower taxes on buildings than land.
The coordinating role of state government is also important. States can restrict the use of incentives to certain geographic areas or certain types of facilities, and reduce destructive local tax competition by not reimbursing local governments for revenue they forgo when they award property tax incentives.
The Greater Denver area established a “playfair” compact in the mid-1980s so that Denver and Boulder, for example — the equivalent of Boston and Cambridgein this context — don’t engage in a race to the bottom in a competition forbusinesses and jobs.States can also assume an oversight role by publishing information on the use of property tax incentives and clear-eyed studies on their effectiveness.
Until that happens, cities like Boston will continue to engage in the practice. One form of defense might be to say that everybody else is doing it. But if government was shown to be wasting $10 billion a year in a program that did not demonstrate any tangible results, there should surely be an outcry.