Will Tax Breaks Boost Jobs?

With the economy slumping and unemployment approaching 10%, states are kicking corporate tax incentives into overdrive. In the past year they've doled out a record $50 billion to spur job growth. Cash-strapped locales are depending indirectly on federal aid to fund the tax-break bonanza. But economists are beginning to wonder whether such initiatives create or save jobs at all. Companies taking advantage of lucrative tax incentives are jumping from state to state—and bringing their jobs with them. Sure, some states will see job gains, but they may be only temporary. As a result, the states' efforts likely won't improve the national jobs picture. The tax-break boom "undermines the economic union, and it misallocates resources," says Arthur J. Rolnick, senior vice-president and research director for the Federal Reserve Bank of Minneapolis. "It amounts to economic warfare among states." How so? Consider the tug-of-war over General Motors. Officials in Michigan, Tennessee, and Wisconsin spent months trying to persuade the embattled automaker to locate a new small-car plant in their states. On June 26, GM picked Michigan. The clincher: some $44 million in incentives, including a 100% tax break on new equipment for 12 years. "From Day One, we said Michigan would aggressively fight for these jobs," Governor Jennifer M. Granholm said in a public statement.

Giving Away Revenue

But GM's decision won't improve the U.S. employment landscape. The carmaker is converting an existing plant in the state and keeping on some 1,200 workers but not hiring new ones. "Most of the time states are [just] giving away tax revenue," says Charles L. Ballard, a professor of economics at Michigan State University. Tax incentives are nothing new. In a bid to boost their local economies, state officials often use financial means to persuade companies to relocate or expand existing operations. Today, they're offering a range of enticements, from grants for relocation costs and worker training to broad-based tax cuts. New Jersey lawmakers just passed an economic recovery package with a massive $1.5 billion in corporate tax breaks and other subsidies. Oregon gave Intel (INTC) $121 million to subsidize new chip plants in the state. Louisiana spent $358 million between 2006 and 2008 on tax credits for films, including $27 million for The Curious Case of Benjamin Button. What's different now is that states are handing out an unprecedented amount of tax incentives at a time when they're living on the federal dole. States, which face a $166 billion budget shortfall this year, together are getting more than $416 billion in government aid. The money is part of the Economic Recovery Act, the $787 billion federal stimulus package designed to revive the U.S. economy and create jobs. Under U.S. law, state governments can't allocate the funds to tax incentives. But given the states' budget holes, economists and policymakers fear federal money is going to pay for them indirectly. "When a cash-strapped state is giving out an enormous tax package and also getting federal money, the left hand, in this case the incentives, is connected to the right," says Greg LeRoy, head of Good Jobs First, a Washington (D.C.)-based nonprofit. Plus, states are ramping up the tax breaks just as many are slashing spending on health care and education—two areas the stimulus money is meant to protect. State officials defend their tax initiatives, saying they have few other tools to boost jobs in the current economic malaise. "If you are working a campfire and you only have embers left, you better get some new kindling," says Jerold L. Zaro, who heads New Jersey's Office of Economic Growth. New Jersey policymakers, who currently offer small businesses $3,000 for each new job, credit the initiative with adding 17,000 jobs in the state. Tennessee points to tax subsidies as a crucial factor in Volkswagen's (VLKAY) decision to build a plant in Chattanooga in 2008. "Incentives are a win-win proposition," says Matthew H. Kisber, Tennessee's head of economic and community development. The job gains, however, may prove fleeting. In 2002, Ohio lawmakers shelled out $1.7 million in tax incentives to Wal-Mart Stores (WMT) to build an eyeglass manufacturing plant in the state. Wal-Mart shuttered the operation in April, citing the worsening economy, and paid back the money. "It's a net-loss game for state and local governments," says LeRoy. "The only winners are the companies playing the tax game." Last year, Caterpillar (CAT) got $10 million in subsidies from Texas to construct an assembly plant that would create an estimated 1,400 jobs. Days after breaking ground in the small town of Seguin, the company announced plans to lay off 20,000 employees worldwide. That has raised fears among state officials that all the local jobs won't materialize. Says Caterpillar spokesman Jim Dugan: "The new facility in Texas represents a strategic long-term priority for Caterpillar." Meanwhile, states often use tax breaks to poach jobs from each other. In March, Pepsi Bottling Group (PBG) began threatening to move its headquarters from Somers, N.Y., if local lawmakers didn't pass favorable tax and other policies. Now both New Jersey and Connecticut are using a slew of tax incentives to lure Pepsi Bottling to their states. Such warring is creating a conundrum for the Obama Administration. The states are an integral part of the U.S. recovery and job-creation plan. Some economists say the only remedy is a congressionally mandated cease-fire; they're suggesting the U.S. withhold federal funds unless the states stop using tax incentives to grab jobs from other states. Says Rolnick of the Minneapolis Fed: "It's time for Congress to act."

Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network

Slashing Services

Amid record budget shortfalls, state lawmakers are tightening their belts, according to a report from the Center on Budget & Policy Priorities, a think tank. Already, more than 20 states have cut programs for the elderly and disabled. Education also is on the chopping block: Some 24 states have reduced funding for K-12 education while more than 30 have pulled back on spending for higher education. As medical costs soar, health care is another vulnerable area, with 21 states reducing services.

To read the full report, go to http://bx.businessweek.com/us-economy/reference/.

    Before it's here, it's on the Bloomberg Terminal.