Friday, June 19, 2009
Two economists, David Neumark and Jed Kolko, recently reported that California's Enterprise Zones are ineffective. The EZ program subsidizes firms willing to locate in specific areas in need of revitalization and job creation.
I suggested to a group of business leaders that state Enterprise Zone subsidies could be put to better use. Because several of them directly benefit from the programs, they wouldn't hear of it. Yet business as a whole would benefit from a shift from area-specific tax breaks to lower taxes across the board.
There are 42 Enterprise Zones in California. Other similar programs include the Targeted Tax Area program (1 location), the Local Agency Military Base Recovery Area program (eight locations) and the Manufacturing Enhancement Area programs (two in existence).
The problem with these programs is that picking specific locations and industries limits the amount of job growth you can get from the tax breaks.
To create the greatest number of jobs, firms need to be free to move where their costs are lowest. Low costs are what make firms competitive; they can price their products competitively. A firm with competitive prices will see its market share grow. This is how to "create" jobs.
For example, if, in exchange for tax breaks, businesses are required to locate in areas with relatively high crime levels, they will face higher costs than their competitors. Much of the tax break will go toward offsetting higher security costs rather than making the firm competitive. As a result, fewer jobs are created.
Offering tax breaks to a business to locate in an area that does not minimize the company's transportation costs (by lacking proximity to a port or rail link) is also a bad idea. Again, much of the tax break would be used to offset the higher transportation costs.
Another inefficiency comes from the fact that firms looking for tax breaks hire consultants to help them. Firms like the Tax Credit Co. are essentially funded by the Enterprise Zone program, as other businesses pay them to navigate the system in search of tax breaks.
The current system clearly funnels funds to where they can do the least good in terms of promoting business competitiveness and job creation. There is an alternative that makes much more sense: Shut down the economic development agencies that run the zones and use all of the funds to lower business tax rates across the board.
With no bureaucracy to support, the total tax break would be greater than the existing EZ tax breaks and subsidies. And none of the tax break would accrue to consulting firms. All of the money would go toward making California businesses more competitive.
To improve the chances for poor neighborhoods to attract business – the stated goal of the Enterprise Zone program – the state could allocate some of the money saved by shutting down the bureaucracy to improve safety, reduce crime and clean up the streets. That would do more to create jobs in those areas than any economic development subsidy.
To the extent that funding for some of these programs comes from the federal government, using the money to offset lower business taxes or to reduce crime in disadvantaged neighborhoods would require approval by the granting authorities, but the state should insist on it.
Efforts to subsidize particular areas are often justified on the basis that local workers need jobs. However, the irony is that when workers in poor communities get jobs, they often move to a nicer area.
If you want to improve poor communities, reduce crime and clean up the streets. If you want to increase business growth and job creation, lower taxes overall, and let businesses locate where the costs of doing business are the lowest. When you dictate location, you get fewer jobs.