Are Local Property Tax Breaks for Businesses and Nonprofits Broken?
Mattoon, Richard H., Chicago Fed Letter
On November 30, 2012, the Federal Reserve Bank of Chicago, Metropolis Strategies, and the Civic Federation held a workshop to explore the role of property tax incentives in supporting business growth, as well as the tax treatment of properties owned by nonprofits.
Local governments increasingly find themselves caught in a vise. On the one hand, they want to stimulate economic development by attracting (and retaining) businesses, often through die use of property tax incentives. On the other hand, they grow concerned about the erosion of their tax base as the number of property tax incentives for businesses - as well as the amount of properties owned by tax-exempt nonprofits - increases. Government officials, business owners, nonprofit leaders, and researchers gathered at the workshop to discuss these and related issues affecting local economic growth and tax revenues.
Role of business property tax incentives
Daphne Kenyon, Lincoln Institute of Land Policy, presented her recent report on property tax incentives offered by state and local governments to entice businesses to move to (or stay in) their jurisdictions.1 Kenyon noted the continued growth in the use of three major types of incentives: 1) tax abatements, which offer a full or partial reduction in property tax liability for industrial and commercial real estate over a temporary period (most commonly, a decade); 2) tax increment financing, or TIF, which involves earmarking future property tax revenue gains to subsidize current improvements (often in designated blighted geographic areas); and 3) enterprise zones, which are designated economically depressed areas in which tax and regulatory relief is offered to entrepreneurs and investors to encourage business development. In 2010, 37 states allowed tax abatements, 49 permitted TIF programs, and 42 authorized enterprise zones.2 Kenyon questioned the effectiveness of these incentives in developing business activity, noting that property taxes tend to account for a very small share of the total costs for most businesses. On average, property taxes equal 0.3% of total costs (for a manufacturer), whereas labor costs equal 21. 8%.3 That said, property tax incentives can be an effective means to draw businesses into specific parts of a metropolitan area. By altering the relative costs of running a business within a metro region, these incentives can influence business location. Kenyon explained, however, that copycat behavior by neighboring states and jurisdictions often reduces the effectiveness of offering incentives to induce business investment.
According to Kenyon, the use of these incentives lacks transparency and independent evaluation. While 44 states produce tax expenditure reports, only 18 include property taxes - with merely eight estimating forgone local property tax revenues due to incentives.4 To highlight the importance of independent evaluation, Kenyon cited two reviews of Minnesota's Job Opportunity Building Zone (JOBZ) program. The state agency's report stated that about 5,500 jobs had been created by die JOBZ initiative; in contrast, an independent evaluation later found that the number was closer to 1,000, at a cost that was about five times greater than the agency's estimate.
Given such concerns, Kenyon recommended alternative strategies, local policy reforms, and state policy reforms. Her favored alternatives involved several nontax policies, such as job training customized to individual firms' specifications, labor market intermediaries (programs that help workers match with firms) , and regulatory assistance (to help resolve problems with state or federal agencies). Kenyon's other nontax policies included business incubators for start-ups and business improvement districts, where property owners agree to pay for expanded public services, such as more police patrols and street cleaning, which may raise property values.
For local governments, Kenyon suggested five policy reforms. …