Research Highlights

When are economic development incentives most likely to have the biggest payoff for state economies?

Switch, a Las Vegas–based technology firm, would like to establish a high-tech campus right outside Grand Rapids, Michigan to house a cloud computing and data storage center. According to Switch, this multibillion-dollar project would entail taking over the iconic but vacant “pyramid” building, formerly owned by Steelcase, as well as erecting additional buildings at the site. Switch predicts that approximately 1,000 employees—plus additional construction and support jobs—would be added to the local economy. However, the firm argues that this project would not go ahead without governmental entities granting the firm significant economic incentives. This request has rekindled the debate among economic development entities and state lawmakers over whether the millions of dollars in tax incentives Switch is asking for would be a sound investment in the local economy or merely corporate welfare. In responding to Switch’s request, the Michigan legislature is moving to exempt all data centers from sales taxes on input purchases and from personal property taxes on machinery and equipment.  The exemption is being considered for taxes on new such personal property but also on existing property.

Institute senior economist Timothy J. Bartik, an expert on state and local tax incentives, views the response of the Michigan legislature to Switch’s request in two ways.  Dr. Bartik says it is difficult to argue against a sales tax exemption on business inputs.  Sales taxes are intended to apply to consumer purchases not business purchases for intermediate goods and services.  Taxing business inputs creates incentives that could distort the structure of businesses in ways that might not necessarily be good for Michigan’s economy.  The legislature has recognized these adverse incentives by exempting sales taxes on inputs for manufacturers in Michigan.  Why not extend it to other sectors of Michigan’s economy, particularly the high-tech sector?

On the other hand, Dr. Bartik questions the legislature’s consideration of extending the sales tax exemption to existing businesses, since it may not be the best use of taxpayers’ dollars if its goal is to encourage job creation. His research shows that tax incentives are most likely to pay off under the following circumstances:

  • When such incentives are only applied to new investments and new job creation, and not to business activity or property that already exists
  • When the jobs created pay a high wage premium, which both boosts multiplier effects and increases average state earnings per worker
  • When a higher percentage of the created jobs go to state residents, which will boost state employment-to-population ratios and tighten state labor markets, thus facilitating occupational upgrading of workers in the state to better-paying jobs

Any benefit-cost evaluation of tax incentives needs to take into account that even without the incentive, a considerable portion of the incented activity would have occurred anyway, or that other substituted business activity would occur. For example, even without incentives, vacant buildings zoned for development will help attract new business activity. Incentives can help speed up this process, and may help target new development toward business activities with a higher payoff for state economies in increasing average earnings per worker. But this requires that incentives be carefully targeted and designed to maximize benefits while minimizing costs. Dr. Bartik presented some of these arguments at a recent seminar in Washington, DC, for state economic development officials.

Bartik has also argued that economic development incentives that are delivered in the form of customized services, such as customized job training and manufacturing extension services, are likely to be more cost-effective than most business tax incentives. In a forthcoming book chapter, based on a presentation given at a conference sponsored by the University of Pennsylvania and the Philadelphia Federal Reserve Bank, Bartik argues that the empirical evidence suggests that such customized service incentives can increase state and local job growth, per dollar of incentives, by 2 to 10 times as much as is true for typical tax incentives.  

For decades, the Upjohn Institute has had an active interest in improving the effectiveness of local and regional economic development efforts. Led by Dr. Timothy J. Bartik and with complementary efforts from outside researchers, the Institute has produced a body of work—books and book chapters, scholarly papers, testimony, etc.—that has helped bring clarity to a subject often clouded by communities’ need to produce jobs and grow the local economy at almost any cost. For a comprehensive discussion by Bartik of these policy issues, see Bartik’s presentation in 2009 to state policymakers in Wisconsin on what works in state economic development policy. Some suggestions for Michigan’s economic development are found in a 2009 paper by Bartik, which is still applicable to the Michigan economy of 2015.

Learn more about Timothy J. Bartik and access all of his research and publications.

Access all of the Institute’s publications on regional policy and planning.

Learn how Upjohn staff assists communities wishing to promote local economic and workforce development.