spending report — frequently asked questions
1) Are all uses of tax incentives or tax exemptions bad?
No. When used selectively and strategically, tax incentives can be an appropriate tool to help finance economic development efforts that move the state forward. However, incentives and exemptions become counter-productive when they dominate a state’s economic development approach and are given out too broadly and indiscriminately. When that is the case, they subsidize businesses for activity that would’ve happened anyway and drain public resources better used for other purposes.
Used wisely and within limits, incentives can target resources where they are most needed—like in key sectors of the state’s economy. But recipients should be required to meet community standards by providing fair wages and benefits, creating jobs with advancement opportunities and promoting environmental sustainability. Tax incentives should only be one part of a state’s economic development toolbox and not the sole tool. Their expense and effectiveness must be closely scrutinized and the decision to use them carefully weighed against other vital needs, like training for entrepreneurs or investment in higher education.
2) Doesn’t using incentives to create jobs grow the tax base, thus creating more revenue?
In a survey of the literature on tax incentives, economist Robert Lynch reports that any economic benefit from the extensive use of incentives is usually more than outweighed by the negative economic effects of cuts to public services — which must happen in states with constitutions that require a balanced budget (like Kentucky). When a state gives a company one dollar in tax incentives, the company may save a portion of that dollar or spend it out of state. In contrast, public spending on education, infrastructure or health care is almost entirely in-state. This transfer can undermine economic gains and harm the state in the long run.
Tax breaks are also not a major factor in companies’ location decisions. One reason is that state and local taxes are not a significant cost of doing business when compared to other factors — particularly the availability of skilled workers, proximity to customers and suppliers and the quality of public services. Many of the factors that matter most require adequate revenue for public investment, which can be undermined with too many tax breaks. Reductions in public investments can actually raise costs for businesses, as when inadequate road repair leads to higher transportation costs for companies. Lynch says that “state and local governments may be wasting billions of dollars annually on tax cut policies that are failing, while underfunding programs that can promote long-term growth and job creation.”
3) Do tax incentives work in Kentucky?
While the state has had some good news over the last twenty years—mostly having to do with gains in education—Kentucky’s economic story is still deeply troubling. There is scant evidence that Kentucky has benefited from its rapid expansion of tax incentive programs. But because of the lack of adequate reporting and accountability measures for these programs, it is difficult to fully assess their effectiveness. One serious concern with Kentucky’s aggressive focus on a strategy of tax incentives and industrial recruitment is the kind of development that results. States that rely too heavily on low taxes and tax breaks tend to primarily attract businesses in seek of low-skilled labor and in need of few public services. These employers provide low-paying, low quality jobs and don’t stick around for long.
4) The Cabinet for Economic Development report the number of jobs that have been created because of tax incentives. Isn’t that a good thing?
The Cabinet typically reports the number of jobs promised by every company that receives tax breaks over the period being reported. But it’s important not to attribute all the new jobs to the tax incentives, because research suggests that there is little cause-and-effect relationship between tax incentives and corporate investment decisions. Companies most often make these decisions based on other factors, and tax breaks are just an extra bonus they gladly accept. Also, statewide job totals may mask important issues. Are jobs being created in parts of the state most in need of them? Are the jobs of good quality? On that note, the state has enacted wage floors for recipients of most economic development incentives that are a positive step towards limiting current incentives to better quality jobs.
When looking at job reports, it’s important to note that the U. S. and Kentucky economy normally add jobs in most years as part of natural economic growth. That is how employment keeps up with growth in the population. Census Bureau data show that since 1990 Kentucky’s working age population has grown by an average of about 26,000 per year. Jobs in Kentucky must increase significantly each year just to keep pace, so an increase in jobs alone is not sufficient for true economic development.
5) Why don’t we have more information about the impact of Kentucky’s economic development efforts?
Most economic development decisions in Kentucky happen behind closed doors. In 1992, the state enacted new exemptions to the open meetings and open records law that keep much information about economic development incentives out of the public record. There is no formal, accessible reporting system that collects information on the activities of companies receiving incentives over the life of the benefit. Unlike most budgeted programs, there are little to no evaluation mechanisms built into incentive programs to assess their effectiveness. And because almost all such programs are permanently enacted, the state is not required to weigh their expense relative to other spending needs when deciding on the state budget. These issues make proper evaluation of these programs—whether by the legislature or an independent source—pretty much impossible.
6) Who is responsible for making sure Kentucky’s economic development efforts amount to something?
The General Assembly, in conjunction with the Governor, is ultimately responsible for determining the state’s approach to economic development. The legislature passes the state’s tax laws and puts in place economic development-related programs and policies. It also enacts the state budget, which determines the Commonwealth’s spending priorities.
Within the executive branch, the Governor and the Cabinet for Economic Development share primary responsibility for carrying out the state’s economic development functions. Kentucky’s Cabinet for Economic Development is partially independent from the rest of state government. It is governed by a Partnership Board made up primarily of business representatives. The Partnership Board is charged with developing an economic development strategic plan and employing a Secretary, who is in charge of the day-to-day operations of the Cabinet.
7) Do most states around Kentucky engage in this sort of industrial recruitment-based economic development?
Over the last thirty years, practically every state across the country has expanded its use of tax incentives to attract companies. Because of this expansion, there is not a great deal of variation between state tax and incentive policies. One reason is that state and local taxes as a whole add up to about one percent of the cost of doing business. The lack of variation is enhanced by federal deductibility—the fact that businesses can deduct state and local taxes paid from federal taxes. Even if one state’s business taxes were higher than another, federal deductibility lessens the difference. The result of the expansion of tax incentives has done less to distinguish states from each other than to make state taxes lower overall.
There is, however, great variation between states in amenities. Amenities are much more important in business investment decisions—especially for those businesses that create high-skill, high-quality jobs. The perceived caliber of universities and higher education institutions, for example, vary greatly between the states and are extremely important to whether successful long-term development occurs.