Opinion: The good and the bad of corporate tax breaks in New Jersey

Richard F. Keevey | February 4, 2021 | Opinion, Budget
Both proponents and detractors make strong points about whether business incentives are a good thing for the state
Credit: Amanda Brown
Richard F. Keevey

States often seek to improve their ability to attract or retain businesses that create jobs and make investments within the state via so-called business incentives. These incentives can take the form of targeted spending programs (such as customized training or infrastructure enhancements for a specific company). But more often they are tax incentives, whereby businesses pay less in taxes if they agree to create jobs and/or make other investments.

New Jersey recently approved $14.4 billion in corporate tax incentives. The law also provided a direct appropriation of $55.5 million to support certain programs principally for small businesses and administrative operations.

There is an on-going debate about the efficacy of these business incentive programs. I was asked many times during recent weeks, “How can the state afford to ‘lose’ $15 billion in its budget?”

My friends noted that New Jersey has many fiscal challenges: a large unfunded pension system, mounting debt and a poor credit rating. Furthermore, the state just approved $4.5 billion in bonds to balance the current budget because of revenue shortfalls attributed to the coronavirus pandemic. How can it afford a $15 billion giveaway in tax revenue?

Likewise, several left-of-center organizations argued that the governor and the Legislature ignored good stewardship of limited state resources, maintaining the programs are a terrible way to spend money. The state is forgoing billions of dollars at a time when it badly needs this money for education, transportation and other critical services, they note.

The counter arguments from the business community, the governor and the Legislature are that, in the current competitive climate among states and among countries, these incentives are necessary to retain and/or attract business and increase economic activity.

Moreover, the proponents say, over time these incentives will prove to be a wise investment. The jobs and other investments spurred by these business incentives will contribute to greater economic growth and, as a result, higher future tax revenues. As such, they represent a type of investment that will produce returns for many years. Otherwise, corporations will not view New Jersey as an attractive place to do business and both future economic growth and critical public investments will be sacrificed.

But some critics also note that, just a year or so ago, the governor railed against similar programs implemented by the previous administration. He asserted that the programs were poorly managed and that they were a political boon to certain favored firms.

This new program, argues the governor, is much better focused and has many safeguards, such as caps on the amount of tax revenue lost, and that these investments are needed to rebuild our struggling economy.

Observations

First, I had to assure my friends that this program will not result in a revenue loss of $14.4 billion in the upcoming budget — a fact that is lost on many people.

However, the ultimate impact on future budgets is a lot more confusing because the incentives are not just for one program or just for one year. Rather, there are myriad programs (eight new initiatives and two retained from the previously expired program), each with different eligibility criteria and purposes. Revenue forgone will not occur in one year but over many years.

It is not clear what the ultimate real cost will be as many of the projects spawned by the incentives will presumably bring new corporations, investments and jobs to New Jersey that otherwise would not have occurred. This “multiplier effect” brings tax revenue to the state — e.g., sales, income and gasoline taxes. Furthermore, there are likely to be revenue gains for local governments as new projects may lead to new or improved property values, which increase the assessed value in a community, and likely boost overall property taxes.

At least conceptually, the net fiscal impact (the costs of the tax incentives relative to any new tax revenues generated) could very well be positive. For example, requirements could be imposed to ensure that the state will award incentives only to capital projects that are estimated to generate revenue equal to some percent/multiple of the direct state tax revenue loss. Some of the programs, however, may not require that offsetting tax revenue be generated, as not all programs are subject to this traditional net benefit calculation.

At present, incomplete information on the number and type of projects receiving state business incentives does not allow any reasonable fiscal estimate as to the final impact of this investment.

Another factor that needs to be considered is the opportunity cost to the state budget. Opportunity costs are the next best use for scarce state resources if the tax incentives were not provided. The decision to pursue new business incentive programs (as well as enhance some existing programs) could divert resources from policy alternatives to which they would have been applied absent the inducements, including conceivably both spending priorities and individual tax cuts.

A complex history

Tax incentives are intended to spur economic growth that would not occur otherwise. Incentives are offered to persuade businesses to relocate/remain, hire and/or invest within a state. New Jersey just revised its entire tax-incentive program because the prior program was judged to be ineffective.

New Jersey is not unique in having implemented tax-incentive programs that were unsuccessful. The literature of tax incentive programs is full of examples of costly incentives with dubious results or outright failures. An observation from the research literature is that states are significantly limited in their ability to influence business behavior — e.g., where to locate or expand their operations, thereby creating jobs and other investments — through tax incentives.

Here are a few of the conclusions drawn from prior endeavors:

  • Tax incentives are rarely the deciding factor for a business to invest in a particular state;
  • Incentive benefits leak outside a state’s border. Consider a worker who gets a newly created job in New Jersey but lives and pays taxes in Pennsylvania;
  • The corporation would have come or stayed without the incentive;
  • One company‘s gain is often another company’s loss;
  • And business incentives could lead to reductions in spending on key state programs.

Conclusion

So, does this mean the new tax-incentive program in New Jersey is doomed to failure? Not necessarily — and I hope not. But it will take a lot of hard work and wise and thoughtful decision-making to increase the program’s likelihood of success.

On the positive side, the state has made an extensive evaluation of the previous program and has presumably learned from its mistakes and shortcomings. The new program design is better with additional guidelines, oversight, and caps.

Furthermore, it should be required that jobs created come with a living wage and other benefits such as health care. Incentives should also be targeted toward localities and regions most in need of an economic boost.

Where applicable, “clawback” provisions need to be included whereby the state of New Jersey recoups the incentive payment (i.e., forgone tax payments) if the business fails to live up to its investment and/or job-creation promises.

Even the best designed programs face pitfalls which can lead to failure or disappointing results. So, it is critical to have on-going monitoring, including reporting to the Legislature and the public on results, such as jobs added, other revenue generated and related outcomes.

Finally, administration of the program is critical. The staff of the Economic Development Authority, the agency responsible for the program, has an excellent reputation in administering such business incentive programs and they must perform these responsibilities at the highest level.

There is simply too much money involved to forgo intensive monitoring and oversight. In a market-based economy, private investment and job creation are critical, and New Jersey must take all reasonable steps to remain competitive with other states and regions.

Business incentives, if carefully designed, administered, and monitored, can be an important tool in the state’s arsenal. Let us hope New Jersey’s newest program proves the doubters wrong.