EconWar




Task Force on Incentives
North Carolina Economic Development Board

Interim Report

November 8, 1995



Contents

Part I. The North Carolina Economy: Overview
Significant Location Projects - Selecting Other States
Part II. Use of Incentives in Economic Development
A. Incentives: North Carolina's Application

B. Incentives and Location Decisions
Part III. Major Task Force Findings and Recommendations
Principles for Strategic Use of Incentives

A. Major Findings: The Economy

B. Major Findings: Incentives
Task Force

Appendix D
[Contents]


Part I. The North Carolina Economy: Overview


Overall, North Carolina's economy has remained relatively healthy despite the significant restructuring as the state and national economy responds to the forces of international competition. North Carolina continues to add jobs at a strong pace, about 100,000 net new jobs per year over the past several years, according to employer reports to the Employment Security Commission. Unemployment remains low, below the national average, and labor shortages are reported in some areas. Growth in wages and per capita income has outpaced the national growth rates.

The nation's economy as a whole is becoming service sector intensive, with manufacturing employment declining as a percentage of overall employment. North Carolina's economy reflects this trend in that in 1976 manufacturing accounted for 35 percent of the state's total employment. While remaining greater than the national average, this figure fell to 25 percent of the workforce engaged in manufacturing in 1994. Nevertheless, in absolute terms, North Carolina added 107,000 net new manufacturing jobs over the last two decades (1976-1994). North Carolina remains the nationís most ìindustrialî state with a higher percentage of its work force employed in manufacturing than any other state. North Carolinaís competitive position to other states has remained secure over the last two decades. Chart 2 illustrates manufacturing earnings per capita for North Carolina and its competitor states. North Carolina continues to lead its competitors in the Southeast and the gap has widened in recent years. Although North Carolina trails Ohio, North Carolina's trend has remained more stable.

The importance of manufacturing to the economy has increased in terms of gross state product. Manufacturing output has grown and manufacturing now accounts for a larger share of the Gross State Product than in the 1970s. While technological improvements have reduced overall manufacturing employment, manufacturing earnings have continued to grow; most of that growth has been in durable goods industries earnings. Earnings would have been flat overall without the growth in durable goods output, and without growth in plastics and chemicals in the non-durable goods sectors. Finance, Insurance, and Real Estate has been the principal contributor to output and earnings growth in the non-manufacturing sectors, followed by growth in the services sector.

The picture in employment growth was somewhat different than in output growth. In 1994, retail trade accounted for 18 percent of total employment; services 22 percent; manufacturing 25 percent; government 16 percent; wholesale trade five percent; transportation, communication, and public utilities five percent; and all others nine percent. In terms of employment growth, retail trade and services were the primary contributors to an overall employment growth of 60 percent over the last two decades. These two sectors more than doubled, while manufacturing employment grew by fourteen percent. Extremely high rates of job growth were recorded in health services (211 percent) and in eating and drinking establishments (201 percent). Fastest growth rates were thus in the sectors with the highest and lowest increases in real wages over the last two decades.

Within manufacturing, net employment increased 107,000 while various sectors experienced widely varying fortunes. Machinery (including computer equipment) had the highest growth rate, 86 percent, followed by electrical equipment with a 46 percent increase. Textile and apparel combined lost nearly 78,000 jobs between 1976 and 1994, although most losses were prior to 1985. Other growth sectors included electrical equipment (46 percent), food and kindred products (32 percent), and all other manufacturing (50 percent). Despite the losses in textiles and apparel, these two sectors accounted for nearly a third of all manufacturing employment in 1994, compared to about 20 percent of manufacturing employment for the Southeast as a whole.

In the last two decades, most of North Carolina's investment has come from expanding industries (See Chart 3). Real investment from new manufacturing locations has declined over the last few years, while that from expansions has grown. However, new industry has created more jobs per dollar of investment (see Chart 4). The absolute number of new locations and expansions has fluctuated from year to year. Recent evidence indicates a slight downward trend in new locations, and a tracking of "favored" industrial recruitment prospects from economic developers in the NC Department of Commerce's Business and Industry Division shows losses to Virginia and South Carolina.
[Contents]


Significant Location Projects
Selecting Other States

PROJECTYEARSTATE OF LOCATION
BMW1992SC
Bose 1992SC
American Koyo Bear 1993SC
Hitachi 1993SC
Solvay1993VA
Mercedes1994 AL
Transamerica1994MO (Kansas City)
Black & Decker 1994SC
UPS1994SC
Parkdale1994VA
Volvo/GM1995 VA
Motorola1995VA
NUCOR Steel1995SC
Kwik Set1995 GA
AMP1995 SC

The impact of the growing use of tax incentives by other states is too recent to show in current data, however; its effects would be reflected in reports from 1994 and following years.

The distribution of earnings and investment remains an economic development concern. Appendix F shows that most investment has occurred in the urban areas of the state (e.g., Raleigh-Durham, Greensboro-Winston Salem-High Point). While investment has been more equitably dispersed when measured on a per capita basis, unemployment tends to be higher, income lower, and poverty higher in rural areas.

The state continues to do well in terms of job creation. Wages and income, however, remain a central economic development issue. While wages and income are growing faster than national averages, the restructuring of the national economy in response to global competition has had mixed effects on real wages. These effects can be seen in North Carolina. (See appendix A for additional charts on NC's economy).

The state's average weekly manufacturing wage in 1993 was $461 compared with South Carolina's at $5186. In addition, the average wage of $9.80 per hour for North Carolina production workers ranks 44th out of the fifty states7. Nevertheless, manufacturing continues to be a principal source of higher wage employment in the state. Real wages in manufacturing grew by 18 percent since the 1970s, more than twice as much as the 7.7 percent growth in overall real wages. Only finance, insurance and real estate and selected services sectors (Health Services, for example) had higher growth rates in real wages. Real wages for retail trade, on the other hand, declined by nine percent over the last two decades.

On the whole, North Carolina's 1994 per capita income ranked 34th in the nation and was 90 percent of the national average9. Despite economic restructuring, a high percentage of North Carolinaís workers remain employed in relatively lower wage manufacturing sectors, with strong employment growth in both higher end (health services) and lower wage (retail trade) sectors. Increasing wages in the state relative to the US will require continued change in the overall economic structure of the state through new investment from high productivity, high wage industries and growing productivity in dominant existing manufacturing sectors.

[Contents]


Part II. Use of Incentives in Economic Development


A. Incentives: North Carolina's Application


Like many words that are applied in public discussion, but rarely defined, the word "incentives" means different things to different people. In the current debate over "incentives", the term is generally used to refer to cash payments or "tax breaks" from a public entity to a private company in order to entice that company to locate new investment in a particular state or community. Incentives are also considered to be a relatively new phenomenon, a radical departure from the manner in which local and state government typically engage in economic development.

Actually, incentives in some form or fashion have existed for a long time, both in other states and in North Carolina. The birth of modern industrial recruitment programs is generally traced back to Mississippi's Balance Industry with Agriculture initiative in the 1930s, when Mississippi began enticing Northern manufacturers to move facilities to Mississippi to reduce the state's dependence on agriculture. Actually, in a broader sense, various kinds of public sector incentives to induce specific private sector investments have long been a part of federal and state development initiatives. In 1791, New Jersey granted a tax exemption to a manufacturing company owned by Alexander Hamilton.

Attracting outside investment to NC has invariably been a public concern. In 1828, Mr. Fisher issued his commissionís report to the North Carolina House of Commons on attracting manufacturing investment to the state.
Are the circumstances of our State such as to render practicable the introduction of this system (manufacturing) among us? We answer they are. The hand of nature itself seems to point out North Carolina as a region of country well adapted to manufactories.

As to capital, owing to the pursuits of our people, it is hard to be commanded here. The wealth of our citizens consists in property that is not easily converted into money. We can find among us but few persons who are able to command either the whole, or a part of the funds necessary to put manufactories into operation; and therefore, for capital as well as for skill, we must be in some measure dependent on the Northern states; and it is certain, when the monied and enterprising men of the North fully understand how profitably the business may be pursued here, they will be the first to embark in it. But if, from prejudice, or from a want of a knowledge of the superior advantages enjoyed here, that should not be the case, then there is yet a way by which capital in sufficient amounts may be collected, to move forward the system. What one or two, or in a few individuals cannot effect, may be accomplished by the union of many persons. Companies may be formed in every county of the State, composed of individuals, each contributing a small amount, which in the aggregate, will make sums sufficient to carry through the object.

The Committee have thus, at grater length than they could wish, presented their view on the policy of introducing the Manufacturing System into North Carolina. They firmly believe that it is the only course that will relieve one people from the evils that now so heavily press on them. The policy that resists the change is unwise and suicidal. Nothing else can restore us.

Let the Manufacturing System but take root among us, and it will soon flourish like a vigorous plant in its native soil. It will become our greatest means of wealth and prosperity.

(From "A Report on the Establishment of Manufactures," made to the House of Commons of North Carolina, by Mr. Fisher, from Rowan, on Tuesday, January 1, 1828.)

Mr. Fisher had great foresight. Outside capital did see the advantages of investing in North Carolina, and it did flourish here. By the 1990's North Carolina ranked first among all states in the percentage of its workforce in manufacturing and ranked among the leaders in announced new manufacturing investment. The native soil proved good for that investment; also by the 1990's, expansion of existing firms accounted for three-fourths of all new manufacturing investment.

The Fisher Committee was correct in understanding that some local investment might be necessary until such time as the state's advantages were obvious. Some of that investment was public investment to attract the outside capital investment that was critical to building the manufacturing system in the state. In the late 1890s, for example, the Statesville Record reported on a local effort to provide land to attract investment by a textile company to Iredell County.

North Carolina and the Fisher Committee were not alone. Southern states have long recognized that a key to economic development was attracting new capital investment. As Southern state economies have matured, these states have been able to depend upon indigenous growth (from birth of new firms and expansion of existing companies) for a greater percentage of growth in new jobs and outputs.

Expansions of existing manufacturing firms in North Carolina accounted for about three-fourths of all announced new manufacturing investment in the 1990s, compared to about half in the 1970s (Refer to chart 3). Beginning in the 1980s, most states (including North Carolina) initiated a variety of programs to stimulate small business development, spurred by David Birch's research on the importance of small business to job growth. In the 1980s and 1990s, most states (again including North Carolina) also enacted programs to improve the competitiveness of existing companies -- through technology transfer, technical and engineering assistance, and provision of capital to finance new products and technologies. While northeastern and central industrial states have acquired much of the publicity for these programs, the oldest Industrial Extension Service is in North Carolina and the largest is in Georgia.

In the process, states created an array of incentives to stimulate new investment, provide direct services to business and industry, assist in developing new markets, provide low cost debt financing, and increase access to seed and venture capital. The North Carolina Economic Development Board estimates that North Carolina spends about $160 million annually in direct state appropriations for economic development. The Governor's Competitiveness Fund accounted for five million dollars of this total in 1993, and only two million dollars in 1995. Total state expenditures for industrial recruitment (including economic development staff, marketing, the Governor's Competitiveness Fund, highway site access funds, and new industry training) account for only about ten percent of total economic development appropriations.
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Approximate Annual Expenditures, 1994-95


Governor's Competiveness Fund (State)$7,000,000
Industrial Development Fund(State)$2,000,000
CDBG Economic Development Loan Fund (Federal)$4,500,000
CDBG Economic Development Infrastructure Fund( Federal) $4,500,000
Highway Site Access Fund(State) $2,200,000
Community College New and Expanding Industry Funds(State) $7,000,000
Targeted Jobs Tax Credit (Tax Credits) $4,000,000
Total$31,000,000

In addition to direct state appropriations, states have used the tax system to stimulate desired behavior in the private sector. A variety of tax credits and exemptions were deployed to stimulate investment in plants and equipment, in research and development, or to improve the availability of capital to finance new companies and new technologies. North Carolina has been generally less aggressive than other states in the use of tax credits as incentives for industrial investment, although tax incentives have been applied for a variety of purposes.The sole North Carolina tax credit directed to industrial recruitment and expansion is the Targeted Jobs Tax Credit, which allows qualifying manufacturing companies to take an income tax credit of $700 per year for four years for each new job created in a distressed county.13 The only other significant tax credit is the Qualified Business Ventures Tax Credit, which permits an individual or business to take an income tax credit equal to 25 percent of the investment in a qualifying business.14

Historically, North Carolina's primary investment in incentives has been financing for worker training, highways, and water and sewer. North Carolina was a pioneer in developing a statewide network of community colleges oriented to worker training. The Community College customized training programs, which provide state funds to train workers for specific positions within a particular company, have been widely copied. The Site Access Program in the Department of Transportation provides funding for highway improvements or access roads to serve transportation needs of industrial customers. Financing for economic development related water and sewer projects has been episodic; currently the principal state sources are the Industrial Development Fund, which is limited to the fifty most distressed counties within the state, and the Community Development Block Grant program, which is limited to projects that will provide jobs principally for low and moderate income persons. The Industrial Development Fund can also be applied to building improvements and utility extensions. The Community Development Block Grant program also provides low cost loans to private companies that create jobs principally for low and moderate income persons. [See appendix C for a brief description of these programs.] The Department of Commerce at one point operated a fund to support the development of local shell buildings, which could be leased or sold to industrial prospects at preferential terms, but that program is no longer funded [Enacted 1973-1993].

The state has periodically funded a variety of mechanisms to provide low cost financing or grants for product development to small and emerging companies. These include grant programs operated by the Technology Development Authority and the North Carolina Biotechnology Center; the legislature later directed that these grant programs be converted to loan or investment funds. Low cost financing was partially underwritten by state government through appropriations to the Rural Economic Development Center for the Microenterprise Program and the Capital Access Program. The principal low cost financing program for industrial facilities is the state's revenue bond program, which indirectly permits access by private enterprise to the lower interest rates for public sector borrowing.

The Governor's Competitiveness Fund, introduced in 1993, incorporated many of the features of these existing and earlier programs. The Fund provides grants to support new investment (by expanding companies or new locations) for industrial sites, infrastructure, facilities, and machinery and equipment. The Fund received appropriations of five million dollars in 1993, seven million dollars in 1994, and two million dollars in 1995. While some commentators saw the Governor's Competitiveness Fund as a dramatic departure in the state's development policy, the eligible uses have been contained in one or more development programs offered by the state at some point in time.

The State of North Carolina has not had an explicit policy governing public funding to stimulate private investment. A review of existing programs and uses of funds suggests the following implicit policy that governs the state's use of incentives.

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North Carolina's Implicit Policy on Incentives

  • North Carolina offers very modest incentives compared to most states.
  • Existing state incentives are focused principally on infrastructure and job training.
  • Tax credits or direct financing are principally available in the state's fifty most distressed counties or the projects that benefit low income people.
  • Incentives are typically limited to manufacturing projects.
  • New investment from expansion of existing industries and new locations are given equal access to incentives.
  • The state makes limited use of tax credits or other tax-based incentives.
  • Most incentives are performance based (paid out as jobs are created, or in fulfillment of contractual agreements).

A review of business and economic development programs in twenty other states found a more aggressive policy toward incentives. This is particularly true of recent legislation in the Southeastern states, but aggressive incentive programs have also been adopted recently in Kansas, Oklahoma, Washington, Indiana, Ohio, and other states. In general, these states have all of the programs North Carolina offers plus more generous use of tax policies.
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Competitor States' Implicit Incentives Policies

  • Their programs are generally larger and offer higher levels of incentives.
  • They offer infrastructure and job training incentives similar to North Carolina.
  • Incentives programs tend to be less geographically targeted and not limited to distressed areas or persons.
  • Incentives are principally for manufacturing but increasingly are used for other "traded" sectors, that is non-manufacturing sectors that sell most of their product outside the state.
  • New and expanding industries both have access to programs.
  • There is far greater use of statutory tax incentives as an inducement for investment.
  • Most programs incorporate some performance elements in the design of the incentive.

To better understand the practical effect of recent initiatives by other states to provide greater tax incentives for new investment, the task force examined the estimated dollar amount of statutory incentives in seven states for four typical industrial projects. The industrial projects were ones that considered North Carolina as a location; two selected North Carolina, two did not. Two considered urban locations and two were interested in non-metropolitan locations. The four industries were refrigeration and service industry machinery; pumps and pumping equipment; hardware not elsewhere classified; and household audio/video equipment. The projected number of jobs and amount of investment were provided by the company during the site location process. Figures on profits, net worth, assets, and business receipts (for tax calculations) were provided from industry profiles in the KPMG Peat Marwick tax competitiveness study.

This analysis provided estimates of statutory, not negotiated incentives or special incentives for major "trophy" projects. Thus these are incentives generally available to any industry that meets qualifying criteria. Excluded, therefore, are training incentives, most infrastructure incentives, and discretionary funds; for practical reasons, local incentives are also not included in the estimates. These should not be considered to be actual incentive packages; rather, the numbers provide our best estimates of the relative size of statutory incentive packages that a hypothetical industrial project would receive. The important figure is the relative magnitude of the totals, not the exact amounts. (See appendix D for more detail on the components of the incentive packages and the specifics on assumptions and methods for calculating incentive packages.) Following the table of incentives, the second table estimates selected major taxes for each industry.
[Contents]


Estimated Statutory Incentives, Case Study Industries



Industry: Refrigeration Pumps HardwareAudio/Video
Investment: $40 million$32 million $35 million$12.5 million
Jobs: 750650 750600
Location: Non-metropolitanMetropolitanNon-metropolitanMetropolitan
STATE
Alabama$12.5 million $8.52 million$11.3 million$3.6 million
Georgia$11.5 million$5.1 million$11.5 million$4.7 million
North Carolina$2.4 million$0$2.4 million$0
Ohio$7.0 million$5.4 million $7.0 million$4.9 million
South Carolina$4.4 million$1.0 million$4.4 million$0.9 million
Tennessee$3.3 million$2.3 million$3.3 million$2.2 million
Virginia$5.9 million$0.9million $1.8 million$0.8 million
Location DecisionNC NCGASC


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Estimated Tax Liability For Selected Major Taxes,
Case Study Industries


Industry:Refrigeration Pumps HardwareAudio/Video
Investment:$40 million $32 million $35 million$12.5 million
Jobs:750650 750600
Location:Non-metropolitan MetropolitanNon-metropolitanMetropolitan
STATE
Alabama: Total
$968,000$968,000 $257,000$1,310,300
Corporate Income$541,600$541,600 0$449,400
Corporate Franchise $426,500$426,500$257,000 $861,000
Propertyabatedabatedabatedabated
Georgia:Total
$823,000$823,000 $351,000$871,000
Corporate Income$650,000$650,0000$539,200
Corporate FranchiseN/AN/AN/AN/A
Property$173,000$173,000 $351,300$331,700
North Carolina:Total
$1,236,600$1,236,600 $715,000$1,464,100
Corporate Income$839,500$839,5000$696,500
Corporate Franchise$64,000$64,000$38,600$129,100
Property$333,000$333,000$676,300$638,500
Ohio: Total
$962,200$1,605,700 0$2,031,500
Corporate Income$962,200$962,2000$798,000
Corporate FranchiseN/AN/AN/AN/A
Propertyabated$643,500 abated$1,233,500
South Carolina: Total
$541,600$541,600 0$449,400
Corporate Income$541,600$541,6000$449,400
Corporate FranchiseN/AN/AN/AN/A
Propertyabatedabated abatedabated
Tennessee: Total$1,176,200 $1,176,200$916,300$1,559,000
Corporate Income$650,000$650,0000$539,200
Corporate Franchise$106,600$106,600$64,300$215,200
Property$419,600$419,600$852,000$804,400
Virginia: Total
$1,082,500$1,082,500 $878,400$1,368,500
Corporate Income$650,000$650,0000$539,200
Corporate FranchiseN/AN/AN/AN/A
Property$432,600$432,600$878,400$829,200
Location Decision
NC NCGASC
Notes on Tax Chart: Hypothetical balance sheets and income statements were used to calculate tax liability, based on models developed in the KPMG Peat Marwick tax competitiveness study. Zero corporate income tax liability results from no taxable income for the year. Property tax abatement differentials within a single state for urban and rural locations result from the assumption that rural locations are within designated enterprise zones, where property taxes can be abated or negotiated. All numbers are rounded to nearest hundred; numbers may not add due to rounding.

The case studies demonstrate the effect of the recent expansion of statutory incentives -- those that companies qualify for automatically if they meet applicable criteria, which typically specify eligible industries, geographic locations, and minimum levels of jobs or investment. Potential incentive packages for new and expanding industry have increased significantly in the last several years as states have tapped the tax codes to provide tax credits as a stimulus for new investment. While specific programs vary from state to state, the larger numbers tend to come from three basic programs:
  • corporate income and franchise tax credits for new job creation or new investment;
  • authorization for companies to withhold a percentage of employees' wages (job development fees), which employees reclaim as an individual income tax credit.
  • property tax reductions, abatement, or ceilings.

In Georgia, for example, a corporate income tax credit for job creation offers up to $15,000 in tax credits over a five year period for each new job created. In Alabama, a "job development assessment" equal to five percent of employee wages can be withheld by the company to defray the costs of debt service for facilities and equipment. Job development assessments have also been adopted in South Carolina (through the new Enterprise Zone Program) and in Kentucky. Job creation tax credits, in some cases limited to certain geographic areas or graduated on the basis of distress, have become widely used, although the amount of the credit varies significantly

To better understand the impact of these incentives, we need to first examine the industrial location decision process.
[Contents]


B. Incentives and Location Decisions


What determines how a chief executive officer or board of directors selects a site for a new facility or added capacity in existing facilities? The array of factors includes overall business costs (taxes, utilities, regulatory compliance), workforce quality, transportation requirements, site or facility requirements, proximity to suppliers or customers, and the often stated "quality of life" factors -- proximity to urban amenities or particular recreational opportunities. Most economic developers can quote the example of a location decision made on the basis of a nearby facility for the CEO to berth his sailboat, or a similar anecdote. Indeed, evidence suggests many location decisions, in the final stages, involve subjective as well as objective factors. Surveys (such as the one presented in the boxes below) offer conflicting information, depending upon the kind of firms interviewed, how the question is asked, who in the company responds, and how the respondent interprets the question.
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What 203 Senior Executives Think About Incentives

  • 73% felt state and local governments are more likely to offer incentives now than five years ago.
  • Income and franchise tax credits and property tax rebates were the favored types of incentives, followed by preferred financing and sales tax rebates.
  • 81% feel incentives don't give a company a competitive advantage, because they assume everyone is getting them.
  • 79% of the surveyed companies are currently receiving incentives
  • More than half the companies had facilities in enterprise zones and were receiving incentives -- principally tax credits or tax rebates.
  • Two-thirds had expanded or relocated facilities within the past 12 months; nearly all the manufacturing firms reported receiving incentives.
  • One third said they would expand or located within one year, and three quarters within five years.
From survey conducted by KPMG Peat Marwick of 203 senior tax or financial executives. Qualifying companies for survey had gross annual revenues of at least $300 million and were in manufacturing, retailing, or distribution. Most companies had multiple locations in an average of 20 states. Median number of employees was 4500, and median capital expenditures budget for next 12-24 months was 25 million dollars. Business Incentives and Tax Credits: A Boon for Business or Corporate Welfare? KPMG Peat Marwick, September, 1995.
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Top 20 Site Selection Factors, 1989-1993
Percent of Firms Rating "Very Important" or "Important"

RankFactorAvg. Rank,
1989-1993
Trend,
1989-1993
1Labor costs 92.8Downward
2Highway access92.5Stable
3Skilled labor86.5Upward
4 Construction costs86.3Downward
5Energy availability and cost 85.9Downward
6Low crime rate85.0Upward
7State/local incentives 84.7Stable
8Tax exemptions83.5Stable
9Health facilities 80.6Upward
10Land availability80.2 Stable
11Housing costs 79.8Upward
12Available financing79.1 Upward
13Ratings of schools 78.9Upward
14Land costs77.6Stable
15Nearness to markets 76.4Upward
16Housing availability75.7 Upward
17Nearness of suppliers 64.1Stable
18Available unskilled labor 62.7Downward
19Climate 59.7Upward
20Major airport access 58.8Stable

Calculated from Area Development Magazine, 1989-1993, and reported in Laughlin and Toft, "The New Art of War," Commentary, Spring 1995.

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The Site Selection Process


Despite rankings, each location decision is individual, based on a companyís determination of the best fit between its needs for profitability and the characteristics a particular site offers that will affect that profitability. In simplest terms, these are the initial investment costs and the ongoing operating costs. Initial investment costs include land, any required site preparation, building, equipment, and employee screening and training. Recurring costs include wages, utilities, taxes, and continuing training needs. Specialized needs may also affect costs and location decisions -- access to specialized university resources, for example, or proximity to a deep-water port.

Global competition and on-going cost cutting have placed a premium on cost analysis -- sites that offer necessary physical and human resources and provide lower initial and recurring costs have a distinct competitive advantage. The current trend toward greater incentives is driven by both push and pull factors. States are pushed to offer more incentives in response to competitors who lower costs through tax or other incentives. Companies place a higher priority on incentives that can lower costs and thus make them more competitive -- particularly if, as the KMPG Peat Marwick survey of corporate executives indicated, companies believe their competitors are receiving incentives, placing them at a competitive advantage if they don't demand and receive them.

Incentives, however, are only one part of the cost calculus. A location can be more cost competitive if, by virtue of public investment or a favorable tax structure, general business costs are lower in that location. Better trained and more productive labor lowers the wage bill (as can lower wages for the same quality labor). Widely available infrastructure, low utility rates, good transportation systems, and favorable tax structures also lower the overall cost of doing business, and thus lessens the need for compensatory incentives.

Many site selection consultants are applying more objective examination of overall costs to determine the least cost site that meets all necessary criteria for a particular company. Fluor Daniels, for example, screens sites first on "must" and "want" criteria. "Must" criteria include essential factors that would disqualify a location if they are not available; these might include, for example, a minimum size site, access to rail, proximity to a major airport, availability of water and natural gas, or other criteria. "Want " criteria are those that, while important, can be viewed as a whole with strengths in one area compensating for weaknesses in another. These include labor quality, operating costs, competitor locations, distance to suppliers, and incentives.

Once must and want criteria are identified, Fluor Daniels then applies a "least cost analysis" to evaluate overall operating costs at competing locations. Incentives and tax concessions are considered as one part of the overall cost comparison, and overall costs are considered as an important but not sole component of the overall decision matrix. Lower overall business costs can compensate for higher levels of incentives offered by a competing location, and particular "must" or "want" criteria can outweigh the overall higher operating costs of a particular state or location.

As Southeastern states (as well as others) have invested over the last decade to upgrade transportation, invest in education, develop customized worker training programs, and provide water and sewer, many of these differences among states have lessened. Manufacturers that are not driven by specialized needs (proximity to a major airport or access to university research or engineering resources, for example) thus become more highly sensitized to cost differentials. For these companies, then, incentives rationally become a significant component of the location decision if they lead to lower investment or recurring costs.

If incentives lower investment costs, or lower operating costs during the start-up period, lower costs mean faster profitability and greater cost competitiveness for that company. Under existing programs in a number of states, tax credits and abatement can lower 5-10 year operating costs for a firm by several hundred thousand to a million or more dollars per year; if costs become a principal component in the location decision, with other wants more or less equal, then incentives are likely to drive the location decision. In the following chart, adapted from an actual analysis conducted by Fluor Daniels, statutory incentives routinely available to a qualifying firm lower operating costs by $22 million over the ten year period. Although incentives may have once functioned primarily to level the playing field by compensating for cost or quality disadvantages for a particular location, they have now become part of the playing field.
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Top Business Climate States


1. North Carolina

NC Ranks First as Relocation Spot

Small to midsize business owners have ranked NC as the most favorable site for relocation, according to a survey by Inc. Magazine. Factors included access to markets and customers, cost of site property, cost of living and reasonable taxes, the magazine reported. The survey reported that the South Atlantic region topped the country as the area most friendly to entrepreneurial businesses over the Mountain and Pacific regions.

From News and Observer, October 18, 1995

2. South Carolina
3. Ohio
4. Texas
5. Indiana
6. Georgia
7. Kentucky
8. Alabama
9. Tennessee
10. Florida
11. Virginia
12. Illinois
Site Selection, October 1994



[Contents]


Part III. Major Task Force Findings and Recommendations


The Economic Development Board, at the request of Governor Hunt, undertook an initiative to review the stateís current competitive position in attracting new investment. In particular, the Governor asked the Board to examine the recent growth of industrial incentives in competitor states, the likely effect on North Carolina, and any appropriate responses. Former Economic Development Board Chairman Bob Jordan appointed a task force of the Board, along with several knowledgeable outside members, to conduct an analysis and report back to the full board.

The task force met four times - in June, August, September and October. The task force heard expert presentations by economic developers, a site location consultant, and a representative of the Governor's Task Force on the Governor's Competitive Fund. The task force also examined a wealth of background analysis on the North Carolina economy, historical patterns of investment and job creation, incentive programs in North Carolina and other states, and the effect of incentives on location decisions. The task force also reviewed reports and position papers on the use of incentives, both favorable and unfavorable.

The task force members wish to stress that while incentives now tend to dominate discussions of economic development, they should appropriately be viewed as only one tool. Like all tools, they are useful not in themselves but in their utility and effectiveness in accomplishing economic development goals. The North Carolina Economic Development Board, through its strategic plan, previously adopted three broad economic development goals for the state:
  • high quality jobs;
  • high performance enterprises;
  • widely shared prosperity.
The plan emphasizes that these goals are dependent on a strategy that encompasses stimulating entrepreneurship, introducing new technologies, modernizing existing industry, sustaining a quality environment, and sharing the benefits of development among people and places. Incentives are one tool, not the only tool, and they are useful and worthwhile only to the extent they are successful in moving the state toward realizing these goals.

The task force also wishes to stress that "incentives" has become a word taken largely out of context by both opponents and advocates. Economic development has always been an undertaking in which both the public sector and private sector have roles. Tax policy, regulatory policy, education policy, training policy, transportation policy - all have to some extent been applied throughout the history of this country to stimulate economic activity. In truth, no one is fundamentally opposed to incentives. People are for good incentives and opposed to bad incentives. Therein, of course, lies the debate.

The task force avoided dogmatic positions on one side or the other and, instead, has attempted to view the issue pragmatically. While the Governor's Incentive Fund has tended to dominate the discussion of incentives, in truth it is one small component of long standing incentive policies in North Carolina. An analysis prepared for a special legislative study commission on incentives examined uses of the Governor's Fund for nineteen projects from December, 1993 through April, 1994. That analysis found that the Governor's Fund represented only eight percent of the total incentives used to attract that private investment. State and local infrastructure financing accounted for 42 percent, training subsidies accounted for almost ten percent, tax credits for distressed counties accounted for thirteen percent, and other local government subsidies accounted for the balance (See Chart 1). We expect similar results would be found for subsequent industrial projects.

The heat of the current debate has been generated by several large scale incentive packages for "trophy" projects over the last few years (Mercedes, BMW, Toyota, Motorola), and by the growing use of tax related incentives. North Carolina has largely avoided both categories. North Carolina has a limited use of tax credits, and the Mercedes package of approximately $110 million was the largest ever proposed by the state for an industrial project. The result, of course, has been that North Carolina has not been competitive for the large investment projects that attracted incentive packages in excess of $150-$350 million. And unless there is a dramatic policy change, North Carolina will not be competitive for these kinds of location decisions.

An issue that has attracted less attention, but that should generate greater discussion, is the growing widespread use of tax related incentives that are statutorily available to all firms that meet the particular criteria. These incentives are routinely available to small and mid-sized industrial projects, as well as the periodic mega-projects, and are likely to have a greater impact on the future location decisions (and expansion in place) for manufacturing and, increasingly, non-manufacturing industries. The task force devoted greater time to understanding this issue than to the bidding wars that have characterized several major projects.

The task force defines "incentives" as public expenditures directed to induce a private company to invest in a particular location by reducing the initial or recurring costs of that investment. Expenditures can be for employee screening and training, transportation or water and wastewater and other utility improvements to serve the site, tax reductions (abatements, credits, or exemptions), subsidized financing (such as industrial revenue bonds), or direct payments to reduce the cost of building, land, equipment, employee relocation, or other costs. (Interestingly, some site location companies expect the site to be "industry ready" and do not count any public expenditures necessary to prepare the site as incentives.)

These expenditures for economic development should be viewed like other expenditures for economic development, many of which provide free or reduced costs services to business (such as technical and engineering assistance, small business services, low cost laboratory services or access to equipment, and so on). The test applied should be: Are these an effective and efficient use of public funds that move North Carolina more rapidly toward the goals and objectives identified in the strategic plan? If so, they are justified; if not, no expenditure is justified no matter how familiar, long standing, and non-controversial it has become.

North Carolina has taken a measured and cautious approach in the use of incentives, and the task force recommends that that approach be continued. The task force does recommend that North Carolina adopt several new incentives that use tax policy to reduce the early costs of an expansion in place or a new location, and thereby make North Carolina more cost competitive compared to other states. We should not attempt to out-bid states for new investment and adopt a dollar for dollar, quid pro quo approach. We must recognize that the terms of competition have changed and react accordingly. Otherwise, we are not honoring the commitment to our citizens to promote high quality jobs, high performance enterprises, and widely shared prosperity.
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Principles for Strategic Use of Incentives

Principle 1. Outcome Based Calibration. Base the level of the incentive on the desired outcome. If the goal is to raise wages, for example, establish a wage or payroll based tax credit.

Principle 2. Insure a Rate of Return. The level of the incentive should not exceed what would be received in tax payments from an economic development project.

Principle 3. Establish Performance Baselines. Reward behavior that would not otherwise have occurred. A training credit, for example, should stimulate training above that already provided, not subsidize current training.

Principle 4. Clawback. Revoke credits or recover payments if prescribed conditions are not met.

Principle 5. Emphasize Capital Incentives Over Cash. Incentives that stimulate investment in training, infrastructure, or capital facilities provide permanent investments.

Principle 6. Use Incentives to Accomplish a Plan. Incentives should be applied to accomplish a clear strategy or plan rather than applied on a case by case or ad-hoc basis.

Paraphrased from Laughlin, James D. and Toft, Graham S. "The New Art of War." Commentary, Spring 1995.

The task force also recommends that North Carolina continue its current policies related to incentives. However, the task force recommends modifying these policies to include standards that direct publicly subsidized private investment toward the state goal of high wages for high quality jobs in companies that are prepared to meet the growing competitive demands of a global economy. The task force also recommends cautious expansion of incentives to non-manufacturing industries that export goods and services outside the state, thus stimulating the economic base.

Sections A and B summarize task force findings and recommendations. The remaining sections provide more detail on the task force analysis and the specifics of recommendations for new incentives. The appendices provide greater detail on background information and analysis.
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A. Major Findings: The Economy


The economy of North Carolina continues to grow faster than the national average. Job growth is strong, with over 100,000 jobs created annually over the last few years. Net job growth disguises substantial volatility, however, as closings and downsizing displace some workers while new jobs are created. Unemployment is below the national average, and labor shortages are apparent in some areas.

Manufacturing is critical to the state's economic future. Manufacturing as a percentage of total gross state product has increased in the last two decades; most of that growth has been in durable goods industries. Finance, Insurance, and Real Estate has been the second major contributor to growth in the state's output, followed by the services sector. Wages and incomes are rising, but North Carolina remains near the bottom in manufacturing wage rates and per capita income remains below the national average.

Most areas of the state are exhibiting growth. Higher growth rates, and higher levels of manufacturing investment, continue to be found in the urban corridors. The distribution of growth and opportunity remains an important economic development issue.

Overall, as noted in the state's Comprehensive Strategic Economic Development Plan, the number of jobs is not a principal economic development issue for the state as a whole (although unemployment remains high in some rural counties). The principal economic development concern is increasing the number and percentage of high quality jobs in high wage enterprises that are poised to be competitive in the global economic environment. Those are most likely companies that use technology and innovation to emphasize low cost, high quality, and responsiveness to market demands.

North Carolina continues to entertain an excellent reputation as a place to invest, ranking at or near the top in most lists that measure business climate or preferred location for new investment. North Carolina also ranks at or near the top in recent national rankings of states in amount of new investment, both domestic and foreign.
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B. Major Findings: Incentives


North Carolina's historical location advantages have included reasonable taxes, relatively low cost but adequately skilled labor, major investments in education and training, and major investments in infrastructure (highways and water/wastewater). The Research Triangle Park, strong universities, and investments in technology stimulated growth in research and technology dependent industries.

Investments and advances by other states have lessened some of North Carolina's competitive advantages in education, infrastructure, and work force. Many states, for example, have replicated North Carolina's efforts in technical and customized industry training.

As companies invest in technology and downsize in order to reduce costs and compete in international markets, investment and operating costs have become an important location criteria. As other location criteria become more balanced, cost have become the principal location determinant in some cases.

Various forms of limited subsidy programs to attract new investment have long been common. Over the last three years, however, states have enacted new statutory programs to provide subsidies for new investment by reducing initial and recurring costs. These programs began in a few Southeastern states but have spread outside the Southeast.

These are not the "negotiated" incentives that are widely publicized for a small number of high profile, "trophy" firms (e.g., Mercedes, BMW, Saturn). Instead, these programs are generally available to any industry that meets eligibility criteria; the criteria usually include some combination of industry sector, number of jobs, amount of investment, and geographic location.

Rather than relying on cash transfers or grants, these programs use the tax code through a variety of credits, exemptions, and abatement. Thus states are routinely able to offer far larger levels of incentives, and to offer continuing incentives that offset taxes and reduce recurring operating costs. Use of these types of incentives is growing.

A favorable tax and regulatory climate, skilled and productive labor, good transportation and other infrastructure, vital and livable communities, and high quality technical and research resources can contribute to an overall lower cost business environment and thus lessen the impact of incentives offered by other states. As other states compete effectively in these areas, however, incentives that effectively lower costs become a greater determinant in the location decision.

North Carolina has a modest incentive policy that principally uses investments in infrastructure and training. North Carolina has avoided extensive use of major tax incentives.

North Carolina's competitiveness for new investment is at risk in the new environment. Other states' initiatives lower operating costs for new investment by hundreds of thousands of dollars to over a million dollars annually. Where other location factors are relatively equal, North Carolina cannot effectively compete for those industrial locations.
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Task Force


Ron Leatherwood, Task Force Chair

Members:

Mark Bernstein, Economic Development Board, Charlotte
Helen-Marie Berthold, Ehren-Haus Industries, Charlotte
Gary Carlton, Director of Business and Industry, Department of Commerce
Watts Carr, President of NC Partnership for Economic Development, Department of Commerce
John Chaffee, Pitt County Economic Development, Greenville
Bud Cahoon, NC Electric Membership Corporation, Raleigh
Daphne Copeland, General Electric, Raleigh
Paul Fogelman, Catawba Valley Hosiery Association, Hickory
Wallace Green, Paragon Industries, Raleigh
Pete Hasty, Economic Development Board, Maxton
Ron Leatherwood, Economic Development Board, Waynesville
D.G. Martin, Economic Development Board, Chapel Hill
John McCracken, Economic Development Board, Greensboro
Norm Samet, Economic Development Board, High Point
Rebecca Smothers, Mayor, High Point
Bobby Suggs, Sprint, Fayetteville
Rick Webb, Western Regional Economic Development Commission, Arden
Arcelia Wicker, Assistant City Manager, Wilmington
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