Officials base subsidies on flawed model

Decisions to spend on incentives fail to consider all costs

October 12, 1999|By Jay Hancock | Jay Hancock,Sun Staff

Why do South Carolina and other booming Sun Belt states face long-term spending crunches even though their job growth is the envy of the nation?

Look closely at the cost-benefit formulas they use to figure whether business giveaways are good deals.

They're tilted in favor of corporate handouts.

The formulas all but ignore the most basic equation in economic development -- that new jobs need new residents to fill them, along with new schools, wider roads, extra police and other government expenses that come with population growth.

The result: States growing through business incentives are placing themselves in multiple jeopardy, interviews with development experts and state officials show. They're slashing tax revenue, spurring growth and then fooling themselves about how much that growth will cost.

In fact, only a few states accurately account for the proven links between job growth, population growth and soaring government costs when they evaluate incentive deals, a survey by The Sun found.

"The research is fairly consistent on this," said Timothy Bartik, economist with the Upjohn Institute for Employment Research in Kalamazoo, Mich., and an authority on development. "In the long run, if you create five jobs, four of them go to people who otherwise would be living someplace else."

Take South Carolina.

With an unemployment rate of only about 4 percent, it has no choice but to reach across its borders to fill new jobs.

But when the state decides whether to award corporate incentives, it calculates that every 10 new jobs will ultimately bring only one worker into a region. That drastically underestimates the long-term expense of incentives, development economists said, causing bad decisions on giveaways.

No wonder South Carolina faces ballooning government costs and looming budget shortfalls, as Clemson University recently reported.

This kind of analytical flaw amounts to a massive hidden cost in most states' economic development incentives.

New businesses cause population growth even if workers they hire already live in the region.

"You can't just look at who is hired by the new plant," said William Conerly, president of Conerly Whelan Inc. in Portland, Ore., and former economist with Oregon's First Interstate Bank. "If somebody moves from the local McDonald's to take a job at the plant, and somebody else moves from out of state to work at McDonald's, that plant has generated a new state resident."

Utah and Georgia seem to have the best measures of population costs that come with incentive-driven job growth. Many states ignore those costs. Most others drastically underestimate them.

Take Maryland. Its method for evaluating business giveaways recently won an award from a national development group.

But how does Maryland calculate the effect of new jobs on population growth and future government costs? It simply asks a company how many workers will be hired locally and how many will be directly transferred from elsewhere. The number transferred is usually very small.

"That's very naive," said Michael J. Greenwood, professor of economics at the University of Colorado and a respected migration expert. "People are going to come. If you hire somebody locally, somebody is going to fill those boots" in the vacated job.

By ignoring the expensive "ripple effect" of job growth on population growth, Greenwood said, Maryland underestimates incentives' costs and might be lulled into deals that are financial losers for taxpayers.

Maryland's model has gotten so popular that Baltimore City, Howard County, Montgomery County, Queen Anne's County and others are adopting it.

Public officials often praise marked-down taxes from new businesses as "money we wouldn't have had otherwise."

But what communities should ask themselves, critics say, is not whether the money is new, but whether it will cover the costs that come with it.

In many cases, it doesn't.

Arizona ignores the costs of new residents when it evaluates specific business incentives. Meanwhile, "our kids are basically going to school in trailer parks," said Veronica Ross, an artist and mother in the Phoenix area, where large trade-zone tax discounts for companies such as Wal-Mart Stores Inc., Conair Corp. and SGS Semiconductor have eaten into school budgets.

Of course, new residents add income and property taxes to local and state government. But many studies show residential taxes aren't enough to pay for growth. In Maryland, Carroll County figures that each new household costs government $2,700 more than it generates in taxes.

Or look at Rio Rancho, N.M. The most famous example of incentives gone awry, Rio Rancho used huge tax discounts to spur spectacular job and population growth in the mid-1990s. Then it discovered it couldn't afford schools for all the new residents.

Pub Date: 10/12/99

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