September 6, 2010
Click here to view and here to listen to Joseph Coletti discussing this Spotlight report.
RALEIGH — Too many government officials pursue targeted tax break deals without gauging the potential costs. The John Locke Foundation’s top budget expert makes that argument in a new Spotlight report.
The report examines a model that could help governments weigh costs and benefits of targeted incentives more effectively.
“Business incentives are like lottery tickets, providing big rewards for governments — but only if you don’t count the costs,” said report author Joseph Coletti, JLF Director of Health and Fiscal Policy Studies. “Most people realize that winning the lottery is not as simple as trading $1 for a $20 million jackpot. You have to factor in the odds of winning, along with the fact that your dollar is worth more today than it will be when the last jackpot dollar would reach your wallet.”
Government officials make a mistake if they treat an incentives deal like a lottery jackpot that has no costs, Coletti said. “Rarely do they examine the full costs and benefits of incentive packages.”
To illustrate his point, Coletti examines the costs and benefits of a PowerBall lottery ticket. Then he turns his attention to a model Iredell County used to justify a recent incentives deal.
“Because of the low odds of winning and the declining value of the dollar over the 29 years of lottery payments, the expected value of a PowerBall ticket does not equal the $1 purchase price until the jackpot reaches $322 million,” Coletti explained. “That’s assuming just one winner and no tax liability. Factor in taxes, and the pretax jackpot would have to be $570 million. The largest-ever PowerBall jackpot was $365 million, which means nobody who ever bought a $1 ticket made a wise investment.”
Like the lottery player who ignores those numbers, government officials trumpeting incentives deals fail to apply proper financial analysis, Coletti said. “Government officials generally look at the benefits of an incentive without weighing the full cost to government beyond the incentive itself.”
Iredell County’s finance manager attempted a financial analysis for tax breaks offered in 2009 to BestSweet, a confectioner with headquarters and an existing plant in the county.
“The model showed benefits for the county, but it started with two flawed assumptions,” Coletti said. “First, it used an overly small ‘discount rate,’ or the rate at which future dollars decline in value. With a more realistic discount rate, potential benefits from the incentives decrease.”
More importantly, Iredell’s incentives model does nothing to account for the likelihood that BestSweet would have expanded its local plant without any incentives, Coletti said. “If the odds that BestSweet would have stayed in Iredell County without incentives were any better than one in three, then the deal ends up being a money loser for the county. Public statements from the company and the local business recruiter suggest BestSweet was most likely to move forward with an Iredell County expansion without any incentives.”
In other words, the county surrendered taxpayers’ money in incentives for no reason, Coletti said. “The project will cost taxpayers more than $119,000 if BestSweet qualifies for all the incentives.”
There is some good news, Coletti said. “At least Iredell County recognized the need for financial analysis of incentives,” he said. “More governments need to follow Iredell’s lead. By focusing on the discount rate and the probability of investment, an incentives decision will be based on the real costs and benefits, not just rhetorical points about who wants jobs and the best way to recruit jobs to an area.”
Applying Coletti’s adjustments to Iredell’s model would offer a “good starting point” for other North Carolina governments, he said. “Before making a decision on incentives, governments should provide citizens a summary sheet with expected benefits and assumptions used for jobs, expenditures, revenues, discount rate, and the incentive’s contribution to the firm’s decision to move or expand. That summary would provide a starting point for public comment.”
The focus on data and numbers should not obscure the fact that targeted tax breaks are a bad idea, Coletti said. “Tax breaks and grants awarded to chosen companies do not actually produce anything,” he said. “They simply transfer money from one group to another that’s politically connected.”
“Until governments decide to stop offering incentives or are forced to stop, they should at least adopt an appropriate financial model to examine the full costs and benefits of those incentives for government revenue,” Coletti added. “A solid financial model is a better place to start than a decision that looks at incentives as a switch that governments must flip to attract business.”
Joseph Coletti’s Spotlight report, “Lotteries and Economic Incentives: Governments need better tools to evaluate tax breaks,” is available at the JLF Web site. For more information, please contact Coletti at (919) 828-3876 or [email protected]. To arrange an interview, contact Mitch Kokai at (919) 306-8736 or [email protected].