Why It’s Important to Estimate How Incentives Influence Business Decisions

Understanding the extent to which economic development tax incentives change business behavior is crucial to measuring the economic and fiscal impact of programs intended to encourage companies to locate or expand within a state. In other words, policy analysts must consider the critical “but for” question: Would the company have made the same decision even if the incentive had not been in place?

To help those tasked with evaluating tax incentives better understand how to assess their impact and convey findings to policymakers, The Pew Charitable Trusts hosted a webinar in May featuring two experts on these issues:  Jim Landers, associate professor of clinical public affairs and Enarson fellow at The Ohio State University’s John Glenn College of Public Affairs, and Ellen Harpel, founder of the Smart Incentives consulting firm in Arlington, Virginia.

Landers, who previously oversaw incentive evaluations for the Indiana Legislature, said evaluators ideally could analyze the cause-and-effect relationship between an incentive and the corresponding economic response by conducting regression analyses or econometric modeling—but also said that is not always possible.

“While this is the gold standard for evaluating the effectiveness of incentives, many times this type of statistical analysis is not achievable because data is not sufficient to do so, or it is not available,’’ Landers explained. “And even if sufficient data are available, these types of methods have significant time and technical requirements.”

Fortunately, as more states regularly review tax incentives, evaluators can refer to an expanding portfolio of analytic frameworks to make reasonable estimates. Landers used state examples to describe various approaches to assessing the effectiveness of economic development incentives, including descriptive data analysis, statistical scenario building, and metanalysis that combines the results of academic studies.

Harpel, whose firm helps develop processes for monitoring compliance and assessing incentive effectiveness, encouraged evaluators and policymakers to apply greater nuance to the “but for” discussion. She suggested that attendees consider an incentive’s influence along a spectrum. Rarely would the incentive have no influence or be the sole deciding factor in a company’s decision to locate a business or bring on more workers.

“An all-or-nothing approach to ‘but for’ ignores the role that incentives play within the context of multiple elements that contribute to a competitive business environment and a successful investment by the company,” she said.

Many location- and project-specific factors, such as access to talent, infrastructure, and site availability, also influence business decisions. In 2019, Harpel, working with the Center for Regional Economic Competitiveness in Arlington and the W.E. Upjohn Institute for Employment Research in Kalamazoo, Michigan, developed what they call a “firm choice” methodology that incorporates these concepts to estimate the impact of incentives.

Drawing on academic literature describing factors that influence business decisions, they used the methodology to evaluate specific projects awarded under the Michigan Business Development Program. To do that, they created scaled scores that hypothesized about the incentives’ influence and, ultimately, their effectiveness.  

The audience for the webinar included analysts who conduct official incentive evaluations in more than 30 states. In support of this work, Pew offers opportunities for cross-state collaboration to improve the quality of the evidence that policymakers rely on when making economic development decisions. A full recording of the webinar, including slides, is available here.

Josh Goodman is a senior officer, Alison Wakefield is an associate manager, and Khara Boender is a senior associate with the state fiscal health project at The Pew Charitable Trusts.