More States Use Evaluations to Reform Tax Incentives

Earlier this year, the Alabama Legislature faced an important decision. Lawmakers allowed Alabama’s Historic Rehabilitation Tax Credit—one of the state’s largest business incentives—to lapse last year. Supporters had argued that the credit had helped boost redevelopment, while critics had feared that renewal would leave the state unable to meet its financial obligations.

Lawmakers understood that in order to come up with the right decision they needed reliable, independent, and evidence-based data. So in 2016, Alabama contracted with researchers at the University of Tennessee to evaluate the Historic Rehabilitation Tax Credit and other Alabama tax incentives. The resulting study— published in February 2017—found that the credit was generally well-designed and had benefitted Alabama’s economy. It also noted ways the program could be improved.

In May, Governor Kay Ivey (R) signed legislation that was based on the evaluation—restarting and reforming the credit. For example, rather than awarding tax credits on a first-come, first-served basis, state officials will now use objective criteria to determine which projects receive credits.

Information on Effectiveness

Across the country, states are making significant progress gathering high-quality information on the effectiveness of tax incentives—and, like Alabama, using that information to improve policy. As recently as five years ago, only a handful of states had regular processes for studying the results of tax incentives. Today, approximately 30 do. In 2015 and 2016 alone, 13 states passed laws requiring regular evaluations. And these laws are not limited to states; New York City and Philadelphia have passed such legislation in recent months. These laws generally set out a recurring multiyear schedule for evaluation, with different programs studied in detail each year by professional staff, such as auditors, economists, and tax policy experts who report their findings to policymakers.

Lawmakers are demanding better information about tax incentives because they recognize the central role these incentives play in their state’s fiscal and economic health. In February, Timothy J. Bartik, a senior economist at the Michigan-based W.E. Upjohn Institute for Employment Research and a leading national authority on business incentives, published groundbreaking research that helps quantify states’ large and growing commitment to incentives. Bartik found that for new or expanding export businesses—which are frequently the focal point of state economic development policy— incentives reduce the state and local business taxes these companies owe by 30 percent. He also estimated that in 2015, the most recent year for which data is available, incentives cost states and localities $45 billion.

Evaluations have helped states make sure that they’re getting their money’s worth for these commitments by providing both quantitative data on the impact of incentives and analysis of the design and administration of these programs.

For example, a 2016 evaluation found that rules of North Dakota’s Angel Fund Investment Tax Credit allowed investments in out-of-state companies, many of which have no economic activity in North Dakota. In response, lawmakers adopted legislation earlier this year to reform the program and encourage in-state investments.

Evaluations to Improve Effectiveness

When lawmakers use evaluations to improve incentives, they can make a positive difference for both a state’s economy and its budget. In February, the Minnesota Legislature was debating changes to the state’s Research Tax Credit when an evaluation cautioned against expanding the program without better data on the costs and benefits of doing so—warning that making the credit refundable could prove especially costly. The lawmakers’ subsequent decision to abandon a proposal to make the credit refundable will save the state an estimated $190 million over four years. Earlier this year, Oregon reported that its evaluation process was saving the state hundreds of millions of dollars. Those savings did not come about primarily by eliminating incentives; instead, Oregon has worked to reform the programs so that they cost less and provide a greater return on the state’s investment.

Now, even more states are working to achieve similar results. Utah and Virginia, which recently adopted evaluation laws, are completing their first studies and joining a host of other states—including Maine, Minnesota, Nebraska, North Dakota, Oklahoma, and Tennessee—that published their initial evaluations over the past 12 months under recently passed laws. Meanwhile, lawmakers in states that do not evaluate incentives regularly—Georgia, Michigan, and Pennsylvania among them—are discussing how to begin an evaluation process.

And many states that already study the effectiveness of their tax incentives are now striving to improve the quality of their evaluations. For example, Connecticut was one of the first states to produce regular evaluations that rigorously measure the economic impact of tax incentives. However, the studies have had little effect on incentive policy, in part because the state didn’t build a strong link between the evaluations and the policymaking process. Furthermore, while the evaluations provide a great deal of detail on economic results, they offer less information on the design and administration of incentives.

Legislation signed by Connecticut Governor Dan Malloy (D) in July is designed to address these issues. Under the new law, to add more expertise in examining program administration, the Auditors of Public Accounts will assist the Department of Economic and Community Development with the evaluations. The legislation also requires hearings on the evaluations to provide a forum for lawmakers to consider the findings.

As Connecticut’s experience shows, properly evaluating incentives takes time, effort, and persistence. But the payoff is worth it: Policymakers gain the information they need to ensure that economic development incentives achieve measurable results and a strong return on investment for states’ budgets, businesses, and workers.

Josh Goodman is a senior officer with The Pew Charitable Trusts’ states’ fiscal health team, which helps states design and implement policies to evaluate their incentive programs.

This piece was previously published in Bloomberg BNA.