Academic journal article New England Economic Review


Academic journal article New England Economic Review


Article excerpt

Early in their paper, Peter Fisher and Alan Peters quote the widely cited explanation offered by Newman and Sullivan (1988) as to why more recent empirical studies of the effects of state and local tax differentials on the location of economic activity support the entirely logical proposition that those effects must be negative and significant, while earlier studies did not (with only a few exceptions). The explanation is highly gratifying to economists: Recent studies are just better than the earlier ones, using better data and more sophisticated econometric techniques. The explanation is valid, by and large.

That explanation also answers the question of why more recent articles reviewing the state of knowledge about the effects of tax and nontax economic development incentives are so much more satisfying to read than earlier ones: The recent ones are just better. This paper is an outstanding case in point. It is extremely thorough in its coverage of the literature. Its economics are impeccable, not something that can be said about some of the literature reviewed, which at times seems to seek explanations in what reduces to irrational choice by business location decision-makers. This is the case with some of the "business climate" literature. And this paper correctly identifies the major defects in most (but not all) of the studies of the effects of nontax incentives and highly targeted tax incentives, although the authors are too courteous to excoriate appropriately those who have generated such errors.

"Omitted Variables"

Later on, I expand on the above paragraph, but first, two points which the paper slides over deserve attention. The first is the overwhelming, in many cases exclusive, focus on manufacturing industries in the studies noted and in the authors' own work. This is of course understandable; varied though the outputs are, manufacturing industries do not differ greatly in the basic nature of their inputs and their locational requirements. The supply of data that are highly disaggregated - sectorally and spatially - is enormously larger than for other nonagricultural sectors of the economy, as is the supply of analytical studies of the characteristics of this sector. Studies of the location of manufacturing go back decades, to an era when manufacturing was a far larger component of the economy than it is now. And, even today, many of the most dramatic location decisions involve large manufacturing establishments. For many places, economic development policy rightly focuses on manufacturing, because such places are highly unlikely to attract any truly large nonmanufacturing establishments (except as companions to new manufacturing ones).

But a virtually exclusive focus on manufacturing leaves many places untouched by economic development policy and analyses of such policies. That includes a substantial number of cities in the northeastern quadrant of the country and surely many enterprise zones, including those that do have a relatively large inventory of vacant land. The point is not that such enterprise zones are plausible competitors for the location of high-end service establishments, but rather that they can be more plausible competitors for establishments in other sectors ("big-box" retailing, for example) than for the kinds of manufacturing firms that have deserted those areas in relatively recent times. The story on tax and nontax incentives is incomplete, as long as it is confined to manufacturing as the target for policy.

The second point that warrants some attention is the one-sidedness of the economic development bargain and how that bears on the effectiveness of tax and nontax incentives. An economic development incentive is effective only if it reduces the costs of whatever it is that the firm is promising to do. The cost reduction takes various forms: reducing out-of-pocket investment or training costs, reducing potential or existing tax liabilities, and reducing or sharing risks. …

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