State and local governments often offer economic development subsidies to attract businesses, but these incentives come with significant costs and questionable benefits. Our friends at the Cato Institute have published an excellent, in-depth study that breaks down the complexities of business incentives, exploring their impact on economic growth, budgetary costs, and the effectiveness of such subsidies in driving business decisions.
By examining recent trends and policy failures, Cato aims to foster a deeper understanding of how to reform these practices for more transparent and fiscally responsible governance. ITR Foundation published Cato’s study, with their permission, broken down into a series of articles. The full study is available on Cato’s website.
Cato Institute Policy Analysis No. 980
By Scott Lincicome, Marc Joffe, and Krit Chanwong
Advocates of corporate incentives routinely allege that the measures generate significant benefits for state and local governments and their communities, but these claims are questionable.
In fact, state and local subsidies often pay companies for investments they would have made regardless of whether a business incentive was offered. Notably, research shows that very few business incentives are directly responsible for causing the investment at issue. In fact, a literature review from 2018 by the W. E. Upjohn Institute for Employment Research found that subsidies and incentives decisively affected only 2 to 25 percent of all investment decisions, implying that at least three of four incentives did not play a crucial role in attracting an investment.21 Similarly, a 2015 survey of North Carolina executives found that the availability of state and local business incentives ranked below more than a dozen other factors in their assessment of the state’s business environment.22
Governments providing these subsidies are quick to credit them with inducing the corporate investments at issue, but, as the aforementioned research shows, such causation is rare. In fact, company statements or actions often show that the incentives did not affect their siting decisions. For example, Cargill applied for a tax incentive from the State of Texas four months after it announced plans to build an animal feed plant within the state. The CEO of another Texas incentive recipient, Freeport ISG’s Michael Smith, said that the $375 million in tax credits his company received “were not a factor in the site decision.”23 Other news reports cite additional cases.24 However, given their vested interests and confidentiality concerns, companies are unlikely to disclose that an incentive did not drive their decision, so there are likely many more unreported cases like these.
Governments providing these subsidies are quick to credit them with inducing corporate investments. However, company actions regularly show that the incentives did not affect their siting decisions.
Advocates of business incentives also claim that the measures—rather than merely reallocating investments and resources from one location to another or funds from taxpayers to businesses—generate “spillover” or “multiplier” effects for local communities, generating economic benefits that far exceed budgetary outlays. However, skepticism here is also warranted, as oft-asserted multipliers and spillovers are rarely confirmed by rigorous economic analysis.
For example, David Neumark and colleagues recently reviewed the effects of the California Competes Tax Credit (CCTC) for businesses seeking to locate or expand in California. The authors estimated that for each CCTC-incentivized job created, almost two additional jobs were added in the employer’s census tract and that overall benefits totaled $5.66 per dollar credited. They also found “little evidence that the program creates significant reallocation of employment or payroll across establishments within firms nationwide.”25 However, the largest and fourth-largest beneficiaries of the CCTC were Lockheed Martin and Northrop Grumman, respectively26—two US defense contractors that, regardless of the availability of tax credits, would have expanded US employment and capital expenditures in response to federal requisitions.
In 2020, Cailin Slattery and Owen Zidar reviewed a $558 million tax incentive package that the State of Tennessee offered to Volkswagen to site a new plant in Chattanooga. They compared subsequent auto industry employment changes in Chattanooga with those in Huntsville, Alabama, a city that was also competing for the VW plant. The employment gap between the two markets narrowed in the first four years after the VW incentive deal was approved in 2008, but then began moving roughly in tandem. During those four years, Chattanooga gained an additional 2,750 auto jobs, well below the 14,000 jobs promised by Tennessee’s commissioner for economic and community development. Based on this case and other data Slattery and Zidar reviewed, the researchers concluded that the evidence for spillover benefits of place-based economic incentives was limited.27
Our analysis of state subsidy data and state gross domestic product (GDP) does not support the often-made assertion that spending more money on incentives leads to better economic performance. For this analysis, we look at aggregate subsidy spending from the end of the Great Recession, 2010, through 2022. Figure 2 shows the relationship between subsidies offered during that period as a percentage of 2022 GDP and GDP per capita. All values are shown in 2023 dollars.
Figure 2
As shown in Figure 2, there is a slight negative correlation of ‑0.2 between GDP per capita and the amount of subsidies offered. In other words, states offering a higher level of subsidies tend to be somewhat less affluent than those offering less generous subsidies. Oklahoma, for example, has offered subsidies worth 3.8 percent of its 2022 GDP while having a GDP per capita of $45,616. In comparison, New Hampshire has a GDP per capita of $60,745 while offering subsidies worth less than 0.1 percent of GDP.28
The data also do not support the notion that a greater level of subsidies helps states catch up to their wealthier peers. Figure 3 shows total subsidies offered from 2010 to 2022 as a percentage of 2022 GDP plotted against the compound annual growth rate of each state’s GDP from 2010 to 2022. The correlation coefficient for each variable is ‑0.15, meaning that more subsidies coincide with slightly slower growth. West Virginia, for example, has offered subsidies worth 4.32 percent of its GDP, yet had a compound GDP growth rate of just 0.46 percent.
Figure 3
Although these correlations do not and cannot prove causation, they should nonetheless give subsidy advocates pause. If corporate incentives were as economically effective as politicians claim them to be—generating substantial positive economic and social spillovers for a state economy—we should expect a positive correlation between subsidies offered, wealth, and economic growth. Instead, we see the opposite.
Lincicome, Scott, Marc Joffe, and Krit Chanwong. “Reforming State and Local Economic Development Subsidies,” Policy Analysis no. 980, Cato Institute, Washington, DC, September 19, 2024.
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