ACRE Policy Analyst Jacob Bundrick and ACRE Scholar Dr. Tom Snyder discussed the unintended consequences and opportunity costs of Quick Action Closing Fund (QACF) spending at the State Agencies & Governmental Affairs – Senate Constitutional Issues Subcommittee on February 5th.

Bundrick and Snyder explained the conclusions of their working paper titled   which takes an empirical dive into the relationship between QACF subsidies and private employment and private establishments in Arkansas’s counties.

The study was released by the Mercatus Center at George Mason University and accepted for publication in the academic journal The Review of Regional Studies.

The Quick Action Closing Fund

The Quick Action Closing Fund (QACF) allows the state to provide cash grants to select entities in the hopes of attracting and retaining businesses within Arkansas. The state legislature has appropriated approximately $176 million to the QACF since it was created in 2007. The Arkansas Economic Development Commission has said the program is responsible for creating or retaining nearly 20,000 jobs in Arkansas.

Bundrick and Snyder in their research find that QACF subsidies provided to businesses within a given county have no statistically meaningful relationship with private employment per 1,000 population and private establishments per 1,000 population over a four-year period after the subsidies are disbursed. They also find no evidence to suggest that a given county experiences any meaningful employment or establishment spillover effects related to QACF subsidies awarded to businesses in neighboring counties. Bundrick and Snyder conclude that the evidence provides reason to be skeptical of the QACF as a job creator.

Unintended Consequences — Including Fiscal Cost

At the meeting, Bundrick said regarding the possible unintended consequences of QACF subsidies:

“There are lots of different things that you might not intend to happen with these subsidies that do happen that have these negative effects. The first one we’ll call crowding out. Basically what that means is we’re giving an artificial cost advantage to select companies through this subsidy. With that artificial cost advantage, they have the ability to perhaps pay higher wages to their employees than existing firms. Naturally, employees would like to make more so they shift from one employer to another. It could be that they use that artificial cost advantage to offer their products and services at a lower cost so they can sell their goods at something lower than what their competitors can.  In some markets where it is relatively saturated you actually get an effect where you create jobs at the subsidized firm and the existing business has to close down. We don’t really see that effect reported that often in things like [AEDC’s] annual report for the Quick Action Closing Fund but there’s lots of academic research that shows that happening. A second unintended consequence there is fiscal cost. This program isn’t free. It costs money and revenue to use it. One way you can raise that revenue is by increasing taxes. We haven’t seen that a whole lot at the state level. Where you can see that pretty clearly is at the county level. Some of these counties will raise sales taxes to fund these types of programs. Just a couple of examples there, Jefferson County and Clark County, have increased their sales taxes to fund these types of program.”

Bundrick also mentioned the possible opportunity costs of the program:

“The other side of that coin is that you could shift public resources from other types of expenditures into the Quick Action Closing Fund. Instead of spending money on highways or paying for comprehensive tax reform or education or something along those lines, you use that money for the Quick Action Closing Fund. Maybe those other expenditures are the ways you could’ve used this money in a way that would’ve been more productive for the broader economy.”

“These Funds Aren’t Actually Effective”

Snyder said he found there to be “no overall effect on employment or business establishments” from the QACF.

Snyder said:

“What we see is that most of the literature says the same thing that these funds aren’t actually effective. This money could’ve been spent elsewhere. What we’re doing is taking taxpayer money and then directing [it] to some businesses. What would happen if we didn’t take that money and spent it in other ways such as infrastructure? Some studies have actually shown that with infrastructure spending there is a good return on that.”

A summary infographic of Bundrick and Snyder’s work can be found here. For more on the pros and cons of targeted economic development incentives, be sure to check out Bundrick’s Policy Review Tax Breaks & Subsidies: Challenging the Arkansas Status Quo.

If you’ve ever wondered why corporate welfare gets such a bad rap, you’ll want to read this post and the five follow-up posts I’ll be publishing over the next few weeks. My goal is to help you understand why governments give tax breaks and subsidies to local businesses and why, even with the best of intentions, these efforts tend to fail and cause new problems. These posts are based on a paper I just published, “Tax Breaks and Subsidies: Challenging the Arkansas Status Quo.”

Economic development is a constant focus of state and local governments. Government officials work to attract businesses, jobs, and investment to the area. They often do this by offering financial incentives, such as tax breaks and subsidies, to select firms. However, financial incentives used to entice businesses come at the taxpayers’ expense. Politicians may enjoy bragging about the remarkable progress they’ve made when they trade tax dollars for a handful of jobs, but they ignore the resulting economic costs. Tax incentives create market distortions that make residents worse off and leave them with less money in their pockets.

Here at ACRE, we want Arkansans to be as well off as possible. To ensure that they are, we want to help you understand the problems with financial incentives, why you should care, and what government officials should do instead to create the best outcomes for each individual Arkansan, their families, and the state as a whole.

What Are Tax Incentives and Subsidies?

When trying to improve economic development, politicians and government officials frequently use two carrots to entice firms: tax incentives and subsidies. Tax incentives aim to attract more business to the state by making it less expensive for businesses to operate in Arkansas relative to other states. Subsidies are grants, or sums of money, that governments give firms in an effort to boost business. Let’s take a look at how each one works.

Tax incentives are always designed to increase a firm’s profitability by decreasing its overall tax burden. They come in several forms:

–Tax exemptions fully excuse firms from paying certain liabilities.

–Tax reductions partially offset the amount a firm is obligated to pay in taxes.

–Tax refunds and rebates repay a portion of the taxes a firm has already paid.

–Tax credits are more flexible: they allow a firm to offset a portion of its tax obligation, and they can often be carried forward to subsequent tax years or be sold in the secondary market.

To see how tax credits can impact a company’s profitability, take a look at this sample profit and loss statement. The yellow highlights show how a business income tax credit, in this case for labor, increases a firm’s bottom line.

How Do Businesses Get Tax Incentives?

To receive tax incentives, firms must meet certain requirements from the government. These vary depending on the tax incentive, but common ones include:

-belonging to certain industries

-investing so much in a particular project

-creating a particular number of jobs

-reaching a minimum payroll threshold

The qualifications often depend on the tax incentive’s purpose, which might be creating new jobs, spurring private investment, or increasing research and development. After all, government officials use incentives to promote their particular agendas. Politicians can attempt to steer business practices with incentives because incentives encourage firms to engage in a specific activity by lowering the firm’s cost of that activity, making the return on investment more attractive.

For example, the Arkansas job creation tax incentive known as is an income tax credit given to qualifying firms based on the payroll of new, full-time, permanent employees. Because the tax credit lowers the firm’s labor costs, the return on investment of hiring a new employee is greater and thus a more attractive option relative to other investments the firm could make. Most recently, , a software engineering, development, and deployment firm, is poised to benefit from Advantage Arkansas. Elyxor will receive an income tax credit for 1 percent of its total payroll. In return, the company plans to hire 45 employees within 5 years.

Using Tax Incentives to Target Preferred Businesses and Industries

Politicians commonly use tax incentives to target certain preferred businesses or industries in which they want to encourage the creation, expansion, or relocation of firms. This targeting is an attempt to steer the economy by lowering the cost of doing business in a desired industry. For example, to six emerging technology sectors:

-advanced materials and manufacturing systems

-agriculture, food, and environmental sciences

-bio-based products (adhesives, biodiesel, ethanol, etc.)

-biotechnology, bioengineering, and life sciences (genetics, geriatrics, oncology)

-information technology

-transportation logistics

Tax incentives aren’t the only tool governments and politicians can use to attract business: they can also use subsidies.

How Governments Use Subsidies to Attract Business

Often, governments issue subsidies under the premise that firms will create jobs or increase investment in the local economy. Subsidies, much like tax incentives, lower the cost of doing business and increase returns on investment. The potential for new jobs and investments to improve economic development makes subsidies an attractive tool for politicians.

Arkansas frequently provides subsidies through the . Both the governor and the legislative council must approve the Arkansas Economic Development Commission’s use of the QACF. The QACF is funded with general revenues, which are funds that come primarily from individual income taxes and sales and use taxes. The legislature allocates these funds across the state’s agencies and programs, including to the QACF. [Related: Making Cents of $18 Million: Voters Decide Whether to Increase Sales Taxes in Pulaski County.]

From its creation in 2007 through end of fiscal year 2015, the QACF has subsidized 73 entities. Some of the largest beneficiaries include Hewlett-Packard in Conway ($10 million), LM Windpower in Little Rock ($6.8 million), and Nordex in Jonesboro ($3.8 million).

Arkansas’s government also provides subsidies through . Amendment 82 of the Arkansas Constitution allows the Arkansas General Assembly to authorize the issuance of general obligation bonds of up to 5 percent of the state’s general revenues collected during the most recent fiscal year (in Arkansas, the fiscal year runs from July 1 to June 30; fiscal year 2016 started on July 1, 2015, and ended June 30, 2016). Amendment 82 bonds are generally reserved for “major economic development projects,” such as the . For a company to receive Amendment 82 bonds, the general assembly must approve the bonds’ issuance by a vote. Because these bonds are general obligations of the state, they become a liability of the taxpayers. In other words, it’s your tax dollars that must pay off the debt the state legislature voted to place on you. Legislators have to find the money for these bonds somewhere, which means they could cut spending elsewhere or, more likely, raise taxes.

Conclusion

Rather than focusing on developing the next special tax break or subsidy, government officials should focus on creating a better business environment to attract and retain businesses. Specifically, Arkansas should implement comprehensive tax reform that not only lowers taxes for all businesses, but creates a more simple, fair, and transparent system.

Stay tuned for my next post, where I’ll discuss why financial incentives don’t have the positive effect on economic activity that their supporters think they do.