Finance

How tax incentives can power more equitable, inclusive growth

For decades, tax incentives have been a major policy tool to spur economic development and attract and retain good jobs. In recent years, however, these incentives have come under heightened scrutiny from the public, with growing concerns over lost tax revenue and localities’ fiscal health.

But tax incentives can influence economic growth and opportunity in cities if they are strategically targeted to the right businesses and business behaviors. With the COVID-19 pandemic triggering budget crises for municipal governments, there is even greater need for them to wield incentives effectively in ways that support inclusive growth, racial equity goals, and fiscal health.

The good news is that cities are experimenting with new evaluative tools and practices that help maximize economic, fiscal, and social benefits. When used together, two of these tools—inclusive incentive scorecards and equity indicators—can allow cities to prioritize areas of high need, understand existing inequities, and ultimately gear tax policies to incentivize specific strategic goals.

An underlying premise of these tools is that when a city tracks and measures specific business behaviors and inequities, it will be better able to define clear tax incentive policy goals from the start. And over time, that city will be better equipped to judge whether certain policy choices are enabling them to meet fiscal health, equity, and inclusive growth goals.

Using inclusive incentive scorecards to target inclusive growth

In our view, the broad goal of economic development should be to put a local economy on a trajectory of higher growth by increasing the productivity of businesses and workers in ways that raise everyone’s living standards. But in the period of historic economic expansion preceding the pandemic, growth was not shared evenly.

The prevailing model of tax incentives has been to reward a narrow set of business behaviors—namely, the creation of new jobs, the retention of jobs under threat, and the creation of construction jobs. (Other important factors such as wage levels, local hiring, and affordability requirements for housing projects have only entered incentive formulas in recent years.)

Recent research by one of us examining economic development incentives in four U.S. cities found that incentives were aligned with some, but not all, of four important inclusive growth principles:

  • Invest in people and skills. Skill development can improve residents’ capacities, supporting meaningful work and wages.
  • Focus on advanced industries. Businesses in these industries can build local comparative advantage and deliver innovation and wage gains.
  • Connect places. Work at multiple levels to connect local communities to regional jobs, housing, and opportunity.
  • Boost trade. Export growth and trade with other markets can deepen regional industry specialization and bring in new income and investment.

An inclusive incentives scorecard can help cities better align economic development policies to drive inclusive growth. This tool—developed by Brookings authors with influence from economic development leaders in Indianapolis, Portland, Ore., and Syracuse, N.Y.—helps decisionmakers better target incentives to generate inclusive growth by focusing on four areas of business behaviors:

  1. Good job creation (living wages/benefits)
  2. Skills training and workforce development
  3. Job access and sustainability (e.g., businesses located in transit-accessible locations)
  4. Business ownership and governance (e.g., diversity, equity, and inclusion practices)

City officials can use the scorecard to look at various employer characteristics and behaviors falling into these four areas, and then rank them across two dimensions: impact and implementation. The impact score captures how much certain behaviors will contribute to inclusive growth. The implementation score captures whether city governments and local partners can track or support a specific business behavior.

Ideally, cities incentivize business behaviors that can be mapped in the upper right quadrant—meaning they are both impactful and implementable. While the scorecard needs to offer a widely relevant baseline of employer behaviors and characteristics, it can and should be tailored to a city’s local economic and institutional circumstances.

The scorecard in action: Indianapolis

A handful of cities have used the inclusive incentive scorecard to target tax incentives in ways that support more equitable, inclusive growth. The city of Indianapolis’ efforts to drive such growth through tax incentives have focused on “opportunity industries.” These industries in Central Indiana can both grow the economy and create good jobs that don’t require a bachelor’s degree, said Mackenzie Higgins, a policy advisor to the city’s mayor.

According to Higgins, a first crucial step toward adjusting Indianapolis’ incentive policies was aligning the city’s leaders and economic development team (which handles transactions) on broad goals and how to quantify success. They set collective policy priorities, including: growing the economy, assisting distressed geographies, and improving access to jobs through training, transit, and child care.

Then the city created a scorecard to evaluate the value of economic development projects. It set a family-sustaining wage baseline for scoring purposes: Only jobs paying at least $18 per hour with health care benefits would be considered in the scorecard. The scorecard, which supports tax abatement policymaking, evaluated criteria that included job creation, job location, and the company’s industry.

Indianapolis also requires companies to invest 5% of their tax savings into either transit, workforce training, or child care support for employees. “Those were three elements identified in our community as barriers to employment,” Higgins said.

In terms of removing those barriers through targeted incentives, Higgins flagged a major lesson learned that city leaders should keep in mind. “Ensuring that we have the appropriate ecosystem of partners to help facilitate training, transit, and child care investments was crucial,” she said. For example, if a company wants to allocate its 5% of savings to workforce training, the city connects the company to a specialized training provider to help grow talent.

“That type of partnership has been fundamental to being able to implement this approach on the ground,” Higgins noted.

Improving fiscal health through smarter tax incentives

Along with supporting inclusive growth, economic development incentives can enhance the ability of local governments to plan, manage, and pay for critical public services and investments. For example, Providence, R.I. structured property tax stabilization agreements with businesses in a way that contributed to the city’s broader efforts to strengthen its fiscal health.

“We’ve used the agreements to expand the city’s tax rolls by incentivizing new development, not just downtown but in the neighborhoods as well,” said Lawrence Mancini, Providence’s chief financial officer. “It’s allowed us to stabilize and expand the city’s tax roll. We’ve gone seven years without a tax rate change.”

Incentives structured with targeted attention to fiscal health can also boost the level of funding for capital expenditures. This increased funding can provide valuable multiyear resources for critical infrastructure, helping to ease a long-term budgetary stressor many localities face.

Growth of “own-source revenues” is another potential fiscal health benefit. It is well documented that when incentives are structured to enable a locality to capture partial or full property taxes from firms that would have otherwise located elsewhere, this important category of revenues can grow. Expanding own-source tax revenues is integral for resource-constrained jurisdictions; tax incentives structured for a multiyear period can deliver especially meaningful results. In order to fully track the fiscal health impacts of economic incentives, localities should adopt a robust Governmental Accounting Standards Board (GASB) 77 measurement framework in their financial statements.

Mapping cities’ equity landscape with equity indicators

As cities look to evolve incentive policies in ways that spur more equitable economic development, a common challenge is uncertainty about needs and trends. Without data establishing a baseline understanding of a city’s unique equity landscape, thinking about which outcomes that incentives should focus on is difficult.

This is complex terrain—and equity indicators can help map it. This flexible tool, developed by the City University of New York’s Institute for State and Local Governance in partnership with New York City, measures a city’s current state of equity and how it changes over time across multiple domains and groups. Equity indicators help cities do three things:

  • Identify and track disparities in outcomes faced by those most likely to experience inequity, and track them over time.
  • Support data-driven decisionmaking about the allocation of resources and policy development.
  • Increase transparency and accountability and give communities tools to share in successes and advocate for change.

Drawing on public data from federal and local sources as well as administrative data from local agencies and organizations, cities across the country have developed custom equity indicators tailored to their specific priorities. Pittsburgh, for example, zeroed in on education, workforce development, and entrepreneurship, among other areas. As shown in the below graphic, city officials tracked multiple indicators within each area.

Fig2

Using this granular data that reveals areas of great inequity, a city’s economic development team can proactively tie incentive policies to urgent needs. When companies knock on the city’s door asking for tax incentives, officials can respond using a data-driven strategic framework that puts money to work where it’s most needed.

“Through the use of equity indicators, we were able to implement a data-informed process,” said Majestic Lane, chief equity officer and deputy chief of staff for the mayor of Pittsburgh. One way the city used indicators was to address particular neighborhoods’ challenges. For example, high housing needs were identified in the predominantly African American Hill District, so a portion of tax abatements related to a project there were required to be used in that community.

“The data gave us a more scalpel approach to see what’s the biggest equity issue in a particular neighborhood,” Lane said.

Developing and implementing new data-driven tools and practices takes time and effort. But the implications are significant. Tax incentive policies and programs can be better designed around equity-based goals and inform fiscal choices. Businesses can be held accountable for specific targets that meaningfully change their investments. That, in turn, increases the likelihood that incentives spark economic development that would not otherwise have occurred—inclusive growth that enhances both cities’ fiscal health and equity outcomes.

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