The empirical evidence shows that targeted tax credits have no significant impact on job creation or economic performance.A 1988 report commissioned by then Senate Majority Leader John Engler evaluated the performance of Michigan's economic development strategies and programs in the course of the 1979-1986 business cycle. Addressing the use of financial and tax incentives, the study described the increasing competition between the states:
The arguments against the conventional incentives approach to business development are overwhelming. Practically every major analysis conducted in the past decade has concluded that standard business incentives packages neither substantially encourage investment, nor boost output or create jobs, yet the revenue losses to the jurisdictions offering the incentives can be substantial.
These studies present compelling arguments that financial and tax incentives of the types now employed in Michigan to attract investment really are not very meaningful--typically accounting for less than one-tenth of the value in a weighted spectrum of Vocational factors. A mounting body of evidence suggests that while such incentives can reinforce other locational determinants, and be the deciding factor in marginal cases where all other costs are identical, such considerations as overall tax levels, a reasonably priced skilled labor force, the relative cost of bureaucratic compliance, efficient transportation facilities, and even lifestyle ambience, can weigh more heavily than capital incentives in investment decisions.2
The report went on to suggest that the key to successful economic growth in Michigan is to focus on economic incentives for research and development.
Other states have already deployed programs similar to MEGA, and the results of these programs have usually been disappointing. Despite headline-making subsidy deals, the empirical evidence suggests that strategic incentives have no impact on either industrial location or overall economic performance across states. The Council of State Governments states:
[A] comprehensive review of past studies reveals no statistical evidence that business incentives actually create jobs They are not the primary or sole influence on business location decision-making and they do not have a primary effect on state employment growth 3
In fact, the most successful states in terms of new and expanded industrial facilities offer the fewest number of incentives.4 Despite the political appeal, the overwhelming evidence shows that MEGA will fail to improve overall employment or economic performance.
The Deceptive Claim of "Creating Jobs"
Credibility of the MEGA proposal hinges on the question of whether MEGA would actually create jobs in Michigan that would not have been created here otherwise. MEGA proponents argue that the incentives would be budget neutral, since tax credits would be offset by taxes paid by the holders of the newly created jobs.
This claim, however, is dubious for two reasons. First, how can the MEGA board know if the investments would have been made even without the tax subsidies? Despite the most thorough site location analysis, it will still be easy for a firm to claim that the MEGA credit is the decisive factor. Development professionals know that companies often make their location decisions, and then negotiate incentive packages after the fact. It is simple for a firm to obtain a competing subsidy offer from another state, even if they have no intention of relocating, in order to receive MEGA tax credits. In this case, Say's law surely holds: supply creates its own demand.
Second, how can the Michigan Jobs Commission know whether the new workers employed by a MEGA qualified investment would not have found work elsewhere in the same community or another part of the state? Any claim that MEGA incentives create jobs must demonstrate that the new employees would have remained unemployed but for the MEGA incentive.
Determinants of Industrial Location and Expansion
The reason targeted subsidies and tax credits fail to improve overall economic performance can be understood by examining the process firms use to determine site location. Firms locate in particular states or regions in order to maximize profits. Various market factors determine the profitability of any location. These include general factors such as access to markets, quality of life, executive convenience, and state and local attitude toward business. Also crucial are costs of production, including the overall tax level, labor costs and productivity, capital costs and availability, the legal and regulatory climate, transportation costs and proximity to suppliers, unionization and right-to-work status, informational spillovers, and public and private infrastructure.
Targeted industrial subsidies are only one of many factors in the industrial location choice; traditional market factors dominate the decision. Incentives matter only marginally when all else is equal; they are at best tie-breakers. State government's job is to make all else unequal by improving infrastructure and the business climate in Michigan so that firms will not be enticed by other states' subsidies.
Perhaps the best illustration of why the value of an incentive pales when compared to intrinsic locational factors is the effect of right-to-work laws. According to an executive from Fantus Consulting, a leading site selection firm,
Approximately 50 percent of our clients indicate during the preliminary stages of the site selection process that they do not want to consider locations unless they are in right-to-work states. We have every reason to believe that this is typical of corporate site selectors in general. As a result, states that are not right-to-work states, and the communities in them, are eliminated from consideration in the initial phase of the site selection process, no matter how strong their other advantages for a facility might be. Rarely, if ever, will an area that has been eliminated in the early stages of a site selection be brought back into contention later in the process.5
Many of the states Michigan competes against are among the 21 right-to-work states. For nearly half of all companies, the absence of a right-to-work law is something even the most ambitious tax credit will fail to overcome.
The Importance of Core Competencies
Although we do not always know why particular industries started in Michigan, we do know why they expanded here once established. A specialized private and public infrastructure provided increasing economies of scale to expanding firms, lowering their cost of production. Once minimum efficient scale was reached, the development of the state's industrial clusters in automobiles, chemicals, and office furniture became path dependent. The state developed core competencies, and firms expanded here because they were established here in the first place.
Targeted incentives do not contribute to the development of core competencies, they only partially offset diseconomies and disadvantages of operating in this state. MEGA tax breaks do nothing to augment the specialized infrastructure necessary to develop or retain genuine core competencies. Since targeted subsidies are now commodities, all states can offer them; they do nothing to differentiate Michigan or enhance our distinctive competitive advantage. Moreover, when a firm chooses a site on the basis of an incentive package rather than on the existence of a core competency, it can quickly leave the state when a more attractive handout comes along. Core competencies require a symbiosis between public and private sectors. Targeted tax incentives distract state government's attention from its functions that build authentic core competencies, and are destined to fail at creating sustained economic growth.