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
State and municipal business subsidies can induce companies to invest locally but are often ineffective and costly, especially when compared to alternative policies proven to encourage investment in a more efficient and equitable way. Recently, states have offered companies such as semiconductor and electric vehicle producers especially large incentives, usually linked to Biden-era industrial policy.
Though these subsidy packages are, like many of their predecessors, already raising economic and practical concerns, incentives remain attractive (if not irresistible) to elected officials because they are highly visible to voters, used by competitor states and localities, and frequently subject to few disclosure requirements.
Thus, while eliminating all state and local incentives would be ideal, this study explores two incremental alternatives that would rein in these measures: greater transparency and interstate compacts. Implementing these fiscal discipline measures would limit the use of incentives and allow the public to analyze and understand their costs.
Business incentives are subsidies offered by state and municipal governments, ostensibly to induce companies to move to, expand in, or remain in a certain jurisdiction. Labor economist Timothy Bartik defines them as “business assistance programs that provide companies with benefits such as tax breaks, cash grants, free land, and free job training.”1 Other types of business incentives include low-interest loans, loan guarantees, ability to issue bonds paying tax-exempt interest, “free” (taxpayer-funded) infrastructure, utility rate reductions, and expedited permitting or reduced permitting requirements. As explained by the Council for Community and Economic Research, business incentives are “designed to influence business investment behaviors for an economic development purpose” in the locality at issue.2
Business incentives do not include government measures targeting individuals or horizontal policies that might encourage investment but do not benefit specific companies, such as corporate income tax rate reductions. Rather, the government-provided benefits are narrowly focused on one or a few companies considering whether to engage in some type of business activity in the jurisdiction offering the incentive. Often, business incentives are tied to specific benchmarks, such as investing a certain dollar amount or employing a certain number of local residents, and can be rescinded (“clawed back”) if a beneficiary company fails to hit promised thresholds.
Due to the lack of transparency and definitional issues, estimating the total budgetary cost of state and local incentives is difficult. Bartik estimated the annual cost at $60 billion (converted to 2023 dollars) based on a review of 2015 data.3 Matthew Mitchell of the Mercatus Center at George Mason University and colleagues reviewed a variety of estimates that ranged up to $113 billion per year (in 2023 dollars).4
The best source of more recent incentive data is the database maintained by Good Jobs First, a policy resource center that promotes accountability in economic development. While governments’ lack of transparency limits the comprehensiveness of the database, the Good Jobs First analysts supplement their review of government financial filings with searches for media coverage of incentive deals. In addition, a “Subsidy Tracker” includes details of each business incentive deal the organization finds, including the value of the benefit provided. Since subsidies can take the form of loans, which may or may not be paid back, Good Jobs First’s subsidy value does not equate to a state or local government’s budgetary cost. Figure 1 shows the total subsidy value of Subsidy Tracker entries by calendar year, excluding federal subsidies.
There was a sharp increase in incentives during 2021–2022, when state and local governments appeared to have been inspired by industrial policy at the federal level.
After peaking in the aftermath of the Great Recession, when state and local government competition for scarce jobs was heaviest, the aggregate value of incentives fell during the latter years of the 2010s. But there was a sharp increase in incentives during 2021 and 2022, a time when state and local governments were awash in American Rescue Plan funds and appear to have been inspired by industrial policy at the federal level to become more aggressive in courting corporate employers. The next section examines two industries favored by the Biden administration that have seen substantial state and local incentive activity: electric vehicles (EVs) and semiconductors.
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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