What Not to Miss on Economic Development Incentives

Overheard while waiting for coffee, two business types were looking at the newspaper, where the main story touted a massive economic development incentive to attract a new employer.

“I wish I could get some of that free money,” said one.
“I’ve been thinking of expanding,” said the other. “I should be able to get a handout.”

Neither understood that the answer to their hopes might just be, “Yes”.

What are economic development incentives?

State and local governments often have tools at hand to attract, retain and expand employers’ businesses within their jurisdictions. The Federal government also has a few programs, but the bulk of the allocations come locally.

The incentives are used to level the playing field so that money is not the determining factor in deciding to locate in one city, skip a move elsewhere, or expand an existing business.

“An incentive has to do with (an area’s) economic growth objectives,” said Josh Malancuk, CPA, CMI, president, JM Tax Advocates. “So each state, county, and municipality can offer varying incentive programs ranging from nothing to something material.” Malancuk said that incentives vary by the property type that a government is trying to grow.

When a business is in the site selection process, it evaluates one site over another by examining its total costs over the next decade. Real estate, construction, labor, operations and taxes are just a few of the factors involved.

In today’s economy, the days of freewheeling cash handouts are gone. Over the past ten years, the workforce has been the most critical factor in facility siting, and many governments offer incentives for workforce training.

What are the different types of incentives?

“(Development incentives) are multi-pronged,” said Denise Dahl, president, Epiphany Planning & Development, LLC. “Cash is everyone’s favorite but not so common. If you’re an economic developer or on the elected side, it’s easier to explain and cover yourself if it’s an infrastructure deal that supports the common good: Water, sewer, roads, all that kind of good stuff.”

Dahl and Malancuk ran through the types of incentives. They are used to implement economic development policy. Both agreed that workforce support is the big offer.

“On the whole, there are tax credits or a credit for the number of jobs,” said Dahl. “A state might give you $6,000 per job created. (Often) this is used to keep existing businesses from expanding elsewhere.”

Malancuk warns that expecting and negotiating incentives is not for the faint of heart. “You can run afoul of things and face hitting clawbacks or give your full rights away,” he said. “Unexpected surprises may pop up if you don’t have someone who is a seasoned navigator help you.”

It comes down to infrastructure to support the business, workforce training to create jobs and tax credits to help a business enter the community.

“Tax abatements are easier to justify,” Dahl said. “They’re used to offset startup costs and help a company ramp up. Plus, (the argument is) the money wasn’t coming here anyway, so it’s not like we’re losing money. We’re just deferring the money.”

How long are some of the incentives?

Incentives are usually a single package spread over five years, sometimes as many as ten years. After years of incentives paid out for nonperforming projects, many states and jurisdictions have gone into reimbursement mode.

The agency contracts with the project to deliver on promises over a set period. The company proves compliance annually, and reimbursement follows. A failure to perform in one year may negate those annual incentives or breach the remainder of the contract.

Why do governments offer the incentives?

“Offering incentives has to do with economic growth objectives,” Malancuk said. “Each state, county or municipality can offer varying programs ranging from nothing to something fairly substantial.”

He said that incentives can vary by land use type, location, types of jobs created and other factors that support economic development policies. According to Malancuk, incentives have been used to stimulate growth in certain types of industries.

“It’s good for a developer to know what a (government) is trying to accomplish for its economy,” he said. Lately, Malancuk said, some communities have started offering incentives for residential development.

“You never used to see economic incentives for housing,” he said. “Now we’re facing a nationwide housing shortage, and incentives help encourage new construction, particularly multifamily.”

Dahl said that when a government has a firm economic growth policy, it’s easier to fit the proposed development to the jurisdiction’s needs to qualify for incentives. Sometimes, the incentive is a concierge service that cuts through regulatory red tape and speeds up the process of getting shovels in the ground.

What qualifies a company to warrant incentives?

Jaye O’Donnell, director of the Mesa (Arizona) Economic Development Department, pointed out that there is no magic national formula for qualifying a company for incentives.

“Cities (in Arizona) often have programs designed for businesses of different sizes,” she said. “It all depends on the adopted policy programs.”

During the Covid pandemic, Phoenix offered economic incentives to companies as small as one employee meeting requirements. Many jurisdictions provide incentives to grow existing companies. Fredrick F. Reichheld of Bain & Co. reported in the Harvard Business Review, it’s easier and more profitable to increase an existing customer (business) than to try and land a new one.

What should companies expect?

Companies should expect a warm welcome from economic development agencies unless they come through the door asking for incentives.

“It’s concerning if a company needs an incentive for a project to pencil out,” said O’Donnell. “We’re going to believe their business model is not sustainable.” A company should expect that there is likely an incentive program to help bring the project to fruition if:

• their plans help accomplish a jurisdictional economic goal,
• the business is in a location where the local government wants the sector, and
• the company wants to be a member of the community.

Dahl says businesses must be professional and approach requests as a partnership opportunity. It’s not an “I want to win” situation.

Recommendations on negotiating incentives

“What the outcome is going to be is based on the level of experience of an economic developer,” she said. “You need to have someone to help negotiate the development agreement. I always say I compare it to taxes. ‘What can I do? My own taxes? Yes. Should I? No.’ The outcome is going to be better if someone is an experienced professional.”

The development agreement is a binding contract between the government and the developer. It spells out all requirements, what the developer must deliver, how much value is assigned to the promises, how much and when the government pays it out, and how compliance is proven.

“The biggest overlying (part of the negotiation) has to do with the fact that you know the incentive diligence process,” said Malancuk. “It does take a good amount of time to do it right.”

He said that the negotiations and the types of incentives are a bit more complicated than they need to be. It can be prudent to have someone who can see “the movie played forward to the end and then walk it back.”

Does it become a bidding war between cities?

There are stories about how one city or state gets into a bidding war to land a particular company. Some of these are shared in “What Makes Economic Development Incentives Successful?”

“We see it a lot in (northern Ohio),” Dahl said. “The Midwest is trying to recover manufacturing, and we’ll see Michigan, Ohio and Indiana competing to outbid each other.” It’s less prevalent in the Southwest.

“Our (22 Phoenix metro area) cities talk to each other,” O’Donnell said. “We all believe that any company landing here has benefits for all of us. We know what’s being offered because we talk.”

She said a company trying to play a city against a city will get dubious results. According to Malancuk, most companies are already committed to a site before they even consider incentives. The project must have value to the company and a chance of success that does not depend on a handout.

How do incentives benefit a community?

Jobs. Infrastructure. Tax revenue. These are the three outcomes governments want to see enhanced when working with a new company.

“The public is more interested (in economic development),” said Dahl. “They start to inquire about what’s being given. It’s no longer, a new business is coming in blah, blah, blah.’ It’s now ‘what’s in it for us, the citizens?’”

She said that it’s a balancing act because tax abatements mean that the new company is requiring services and hiring locals and outside people, which means more houses, traffic and students. The abatements also take money from the schools and governmental revenues.

“If there is transparency, everyone knows what’s being returned to the community for offering incentives,” said Dahl.

Businesses seeking incentives normally have to offer jobs paying more than the local mean or median wage plus benefits. Community members get a boost from the new jobs and wages. Outsiders bring fresh blood to town.

When infrastructure is upgraded—new or improved roads, increased water and wastewater capacity, additions to the power grid—this is something measurable that might not have happened if the business hadn’t come to town.

Despite tax abatements, the new business contributes tax revenue. It may be discounted for the first five or ten years, but companies pay sales and employment taxes and buy goods and services in the local economy—if it’s negotiated into the development agreement.

Treating the economic development deal as a partnership between the expanding or incoming company and the local government creates a win-win situation.

To get the best for both sides, particular expertise is required. “You don’t want to go out on this negotiation alone,” said Malancuk.