Opinion: Carolina Beat

No. 628: The Fallacy of Business Incentives

The North Carolina General Assembly recently passed a new package of business incentives designed to lure businesses and jobs to the state’s economy. Business incentives are an old technique, and privately many advocates admit they wish the incentives wouldn’t have to be used. But, the promoters say, other states use business incentives, so to remain competitive, North Carolina must do likewise.
Yet business incentives have hidden costs and potential adverse consequences. When these are exposed, incentives lose their luster and sensibility to an alternative way of promoting economic development.
At the heart of the argument for business incentives is the assumption that state officials can identify winning industries. The idea is to select companies of industries that will prosper in the future and then subsidize, with incentives, their location in North Carolina.
Sounds easy, right? Wrong! Although many economists, business analysts, and futurists may advertise they can pinpoint winning industries, in reality this is very hard, if not impossible to do.
Business formation doesn’t move on a straight and predictable line. Supply, demand, and markets are always changing. Only people at the “ground level,” such as entrepreneurs and venture capitalist investors, can even hope to keep track of the fast and unpredictable movements in the business world. Certainly academics in their ivory towers and bureaucrats at their downtown offices can’t, with any degree of certainty, determine what inventions and innovations will move the economy in the decades ahead.
There are other problems with business incentives. In applying for business incentives, companies will make projections of jobs and spending. But there’s no assurance these projections will be correct. A recent study of South Carolina auto manufactures found actual job and investment performance fell short of the performance predicted by original impact studies.
Business incentives for new companies are unfair for existing companies in two possible ways. First, existing companies, simply because they’re already located here, receive no help from the state and, indeed, their taxes help subsidize the incentives for new firms. Second, the incentives subsidize new firms that will compete for workers and perhaps product sales with existing companies.
Business incentives don’t come cheap. Some states have effectively paid hundreds of millions of dollars of incentives to single firms. States bet the incentives will eventually more than pay for themselves with added new tax revenue. But to finance the incentives, states must increase taxes or cut other spending that might contribute to economic development, and these actions may actually deter other economic growth. So there’s no guarantee the state’s bet will pay off. South Carolina, a heavy user of business incentives, has the highest tax burden in the Southeast.
In the 1990s, North Carolina was a modest user of business incentives, compared to other states, and yet, North Carolina prospered. North Carolina was a leader in the nation in many business and investment categories, and the state’s economic growth rate was greater than the nation’s.
How could this happen without the massive use of business incentives? Simple. It’s because businesses consider many other factors besides incentives when deciding where to locate. Labor availability and cost, access to markets and suppliers, quality of education and training facilities and programs, and the extent and quality of the transportation system are some of the key characteristics businesses look for before they consider business incentives.
So rather than selecting companies on which to shower riches (incentives) — and remember, these companies may or may not prosper — an alternative approach is for the state to use its scarce resources to create an attractive economic environment for any business. Focus the state’s attention on developing and maintaining first-class educational and transportation systems. Reform the state tax system to make it simpler and less burdensome. Review the benefits and costs of state regulations affecting business and streamline the regulations where needed.
The alternative approach eliminates the unfairness to existing companies associated with incentives by treating existing and new businesses the same. The alternative approach is also a less risky strategy because the spending is on characteristics and amenities that apply to all businesses. Using investment terminology, the alternative approach is a diversified one, whereas incentives put our “economic eggs” in only a few baskets.
We don’t want to bribe businesses to come to North Carolina with targeted tax and public spending gifts. Instead, we want businesses to be attracted to North Carolina because of our attractive human, physical, and natural attributes. If the state focuses on this basis tenant, we’ll run rings around states using big, and costly, incentives.