Economic Outlook - June 2009

North Carolina should eliminate most of its tax credits for job creation and investment, according to a study done for the General Assembly. The credits, which make up 98% of the $2 billion the legislature committed for economic incentives between 1996 and 2006, no longer further goals they were created for. The study also recommends cutting the state’s corporate income tax rate while keeping credits for research and development and expanding discretionary incentives such as the Job Development Investment Grants and the One North Carolina Fund. Brent Lane, director of the UNC Center for Competitive Economies, is co-author of the study.

BNC: Has the incentive program been a waste of money?

Lane: No, it hasn’t. We entered a new era of economic-development competition in the ’90s when incentives were extraordinarily useful. North Carolina didn’t want to do incentives — we had to because everybody around us was using them. But the state’s portfolio of economic incentives was developed for the economy of the early ’90s. That economy has changed, so we need to look at our existing portfolio and see how it should be changed.

What are incentives supposed to do?

You’ll get a different answer from almost everybody. But we had a very good bipartisan committee of about 20 legislators. They boiled it down to three primary factors. One was job creation — not just any jobs but higher-wage jobs. Second was an emphasis on job creation in distressed areas where the market isn’t immediately responding to opportunities. The third was: Have we improved the North Carolina economy’s competitiveness?

How do you measure that?

First, you have to have a significant number of jobs. Second, they have to be high-quality. Third, you’ve got to have an effect beyond the company that’s receiving incentives. If you’re going to invest in a relative handful of firms, they have to be transformative in some way.

They have to draw other companies to the state?

Absolutely. Or it can be geographical. A company moving into Mecklenburg County would have a smaller impact than a similarly sized one moving into a distressed rural area.

What did you find the tax credits were doing?

What we found was the popular perception of our incentives doesn’t match the reality. Very little of the tax credits are directly related to job creation. Most are for investments in machinery and other equipment. Those credits, which are more than two-thirds of the total, are not even indirectly associated with job creation. On a net basis, they’re associated with job loss. The vast majority of incentives are to companies that are shedding jobs. If your expectation is that your incented companies are adding jobs, then you’re failing. If you want to incent companies in distressed areas, you’re failing. The tax credits go overwhelmingly to the well-off counties.

Sometimes the state gives incentives not to create but to keep jobs.

People sort of backtrack a bit. “We also want to help these companies remain competitive.” Or, “Now we want to retain jobs.” Then you get into a hospice development. “We want to slow the rate at which these companies decline.” The reason this committee was formed back in early ’07 is the legislature had seen the Google deal [potentially worth more than $100 million in state and local incentives] and the Dell deal [$280 million], and they got pulled into a special session about Goodyear [$30 million to retain jobs]. And I believe they realized that we no longer knew what we wouldn’t do. The tax credits were more effective in their early years than they’ve been in their later years. For the criteria of job creation in distressed areas and enhanced competitiveness, they are not successful any longer.

Why don’t the credits create jobs?

In part, it’s who takes them. Most are taken by mature companies that are not in their most productive stage. An athletic metaphor might be helpful. Do we incent Brett Favre when he’s on the Jets and he has one year left in him? Or do we incent Brett Favre when he joined the Packers and had most of his career in front of him? Also, an economic developer is typically not involved in getting the credits. An accountant typically will find out about an incentive a year, perhaps two years, after the corporate decisions were made. That’s not a stimulus. That’s not an influential incentive. And the vast majority of the tax credits fit into that category. So we were spending a lot of our incentive budget on tax credits, most of which it could not be argued had any effect on business decisions.

Why not get rid of all tax credits?

I won’t make the case that R&D tax credits are creating jobs, but they are strongly correlated with companies that are growing — young Brett Favre companies.

Why are discretionary incentives better?

They have an enforcement mechanism. With tax credits, if you file that you made X dollars of investment, there’s generally no verification of that. Discretionary incentives represent a contractual commitment by the company that is verified. The company commits that it will make an investment and it will hire employees at a stated wage rate. All of that is established in the development agreement ahead of time.

When are incentives most effective?

When they go for headquarters. Headquarters are less likely to shut down than a subsidiary is. When they make profits elsewhere in the world, the profits come back into our economy. When a subsidiary makes a profit, it leaves our economy.

What would happen to the corporate income tax rate if the state eliminated the ineffective tax credits?

You could bring the rate from 6.9% to 6.6% or 6.5%. Right now, our corporate tax rate sticks out. Having a conspicuously higher rate than the rest of the region has a definite but difficult to calculate marketing disadvantage. At 6.5%, it would be competitive-neutral. It would essentially tie with the highest of two or three other states in the Southeast, but it wouldn’t be conspicuously higher. And far more companies would see a benefit than they see in the current tax-credit regime. The tax credits basically reduce the tax rate of the companies who are aware of them at the cost of the ones who aren’t.