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Keys to Fairly Assess the Effective Return on Investment from Public Business Subsidies

IFP BACKGROUNDER

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The following are key factors to assessing the return on investment of public economic development programs, tax credits and expenditures.

Most importantly, it is critical to establish a credible way to estimate the degree to which any state economic development program, tax credit, or expenditure actually produced the economic activity and the degree to which the activity would have occurred anyway.This must go beyond beneficiaries’ claims about the value of the business subsidy, to hard evidence that a subsidy or set of so-called “incentives” tipped the balance to assure at least a portion of the investment. After this determination, a methodology for calculating public ROIs must address these key issues:

  • Calculate public investments in terms of public returns, not increased overall economic activity. Public returns involve increased revenue to the state (in taxes and fees) as a result of the increased business activity, and are the way to measure public (tax dollar) investments for their returns.
  • Establish a reasonable time frame for making these estimates, with returns in future years appropriately discounted. A public investment, like a private one, needs to produce returns over a reasonable time period, and future returns should be appropriately discounted.
  • Compare the return on investment in economic development expenditures with the potential gains from alternative uses of the funds. A proper analysis would account for the lost opportunities that would come from making those investments elsewhere.
  • Estimate the impact of the investment on the direct level of economic activity that is projected to occur, including any potential for displacing existing economic activity. The public interest is in net new economic activity, not displacement of one activity with another, which also can provide unfair advantages to new over existing businesses. Displacement occurs when a subsidy simply enables one business to capture an existing firm’s share of a state market that is not expanding.
  • Incorporate additional public costs, as well as benefits, from the economic activity. There may be additional public sector costs that have to be factored in, particularly for additional demands on public services and business-related infrastructure needs or workforce expansions when new economic activity draws people (and service users) to Iowa from outside the state.
  • Only count any return once, even if multiple, independent investments were made to produce it. When multiple economic development subsidies are used to produce increased economic activity, the public return from that activity needs to be apportioned among those multiple subsidy programs, so it is not counted multiple times.
  • Recognize that ROI is only one factor to consider in determining public purpose and benefit.  Some investments can produce economic gain, but at a public cost (environmental degradation or public health and safety). Others can produce public benefits in those areas.  Although these do not have a monetary value, they are important considerations in making public investments and need to be recognized in ROI analyses.
  • Audit for impact and accuracy. Estimates and claims are only estimates and claims; there needs to be monitoring for actual impact, use, and achievement of public goals.
This is a summary of an Iowa Fiscal Partnership Policy Brief, “Bang for the Buck: Calculating the State’s Return on Investments in Economic Development,” by Charles Bruner and Peter S. Fisher (January 27, 2010). www.iowafiscal.org

IFP Statement: Tax Credit Review Panel ‘Did Its Job’

1-page PDF of this statement
Tax Credit Review Panel Report (11 page PDF)

“The Governor’s Tax Credit Review Committee did its job. The committee took an important step to make Iowa business subsidies more accountable and transparent.

“Most notable is the committee’s rejection of the ‘refundability’ of the research activities credit, or RAC, for large companies. As the Iowa Fiscal Partnership has often pointed out, this has cost Iowa’s treasury many millions. RAC refunds are estimated to have cost the state treasury almost $42 million last budget year, most of that ($36 million) to only 10 companies. This proposal would end the practice of the state cutting secret checks to companies, not as ‘refunds’ of taxes paid, but simply unbudgeted payments shielded from public view.

“We also note other important reforms proposed by the panel: a five-year sunset on all tax credits, and including all business-related tax credits under the $185 million cap passed last year. Both moves would contribute to a much more accountable budget process.

“We need more information about the proposed ‘five-year carryforward’ that large companies would be allowed for the RAC. Any change should not undo the good start on RAC transparency reforms adopted in 2009.

“The Iowa Fiscal Partnership and the state Department of Revenue have illustrated for some time that Iowa has a growing problem in the area of spending through the tax code. This has shortchanged critical services at a time they are most needed. Iowa taxpayers deserve to know they are getting the best bang for the buck, and the lack of attention to this kind of spending has prevented this.

“Today’s recommendations from the review panel can help put Iowa on the right track.”

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For more information about Iowa’s state fiscal situation, see the Iowa Fiscal Partnership website www.iowafiscal.org. The Iowa Fiscal Partnership is a joint budget and tax policy initiative of two nonpartisan, Iowa-based organizations, the Iowa Policy Project in Iowa City and the Child & Family Policy Center in Des Moines.