Study: High-Tech Tax Subsidies Do Little Good

Published February 25, 2010

Pennsylvania’s attempts to lure high-tech companies by offering big tax incentives have brought only marginal gains, according to a new study.

The Keystone State had a net gain of 43 high-tech employers between 1990 and 2006, but a net loss of 2,850 jobs, according to the study, funded by the Pittsburgh nonprofit Heinz Endowments and conducted by a Washington nonprofit organization called Good Jobs First.

“The quantitative evidence is overwhelming: Pennsylvania’s tax rates and existing regimen of incentives are clearly not an issue compared to those of neighboring states,” the study said. “The state has numerous better ways to invest economic development resources than granting costly tax-break packages to individual companies.”

The Heinz Endowments focuses on improving southwestern Pennsylvania’s economy and culture. Good Jobs First researches state and local jobs subsidies.

Tax Incentives Not Enough

The study contends that the job losses show the tax incentives aren’t enough to offset other factors, such as globalization. It said Pennsylvania’s tax code and legislative incentives provided “little appreciable advantage or disadvantage” over neighboring states it competes with to draw high-tech companies—including Maryland, New Jersey, New York, Ohio, West Virginia, and tech-centric North Carolina.

“If you’re trying to generate new jobs, you need to have [the targeted tax cut] arrow in your quiver, but [in the tech industry] it’s not a real driver of investment,” said Nathaniel J. Stumpf, director of prospect development and qualification for Development Counsellors International, an economic development and tourism marketing firm based in New York City.

Much more important to technology companies and other firms is the availability of qualified workers, office space, and other resources, according to Stumpf.

“That’s what we see in our outreach in trying to get companies to move to Pennsylvania or any other state,” Stumpf said.

Industry Changes Quickly
Utility costs are another important element of a company’s decision to relocate, Stumpf added. Pennsylvania is ranks in the top third of states in power costs, he said.

A better choice than targeted tax cuts, according to Stumpf, would be a cut in corporate tax rates.

One of the problems with targeted tax cuts for technology firms is the difficulty in predicting what technologies will remain important as the economy and technology changes, Stumpf said. Another problem is the continual changes in the technology industry, including globalization.

“Targeted tax cuts have a long lead time before they can make a difference. The technology business changes very quickly. Trying to catch the right technology at the right time is one of the potential pitfalls.”

‘Clawback’ Option Can Backfire
This is true of business in general, not just technology, says Stumpf, pointing to the targeted tax cuts for manufacturing jobs that were in vogue in the 1990s. Despite those targeted cuts, many of the manufacturers didn’t survive or still cut a lot of the planned jobs.

Some of those cuts led to “clawbacks,” with the taxing body attempting to recoup some or all of the tax breaks if the company didn’t meet its requirements—for example, meeting employment targets. But there are legal costs and delays in attempting to recover these taxes, meaning lost revenue for the taxing authority without the expected advantage of the new business.

Clawbacks aren’t always successful, Stumpf added.

“A lot of it depends on the wording in the original agreement,” he said.

Tech Cutting Geographic Ties
One of the biggest changes in technology in the last few years has been the fast-growing use of virtualization, such as cloud computing and Software-as-a-Service (SaaS), Stumpf says. Virtualization includes onsite and offsite sharing of computer hardware—”in the cloud,” on offsite, third-client servers—and SaaS enables companies to purchase software services as they need them.

By “renting” these hardware and software services instead of buying them outright, companies can cut back dramatically on their hardware and software purchases, as well as their in-house IT staff to operate these systems.

Vibrant Tech Areas Sought
Some, though not all, of these jobs go overseas. Others go to Silicon Valley or other areas with established technology infrastructures that include potential business partners and support businesses—such as law firms—and low-cost utilities and other resources.

“I love Pennsylvania. I live and work here; it’s a beautiful state,” said Scott Testa, professor of business administration at Cabrini College in Philadelphia. “But it’s not the center of the universe as far as technology is concerned.

“That’s Silicon Valley or, to a lesser extent, the Boston area,” he added “Most tech start-ups are small anyway, so they would have a very small tax burden. High-tech companies want a good ecosystem of technology business partners, lawyers, accountants, and talent. Despite globalization, there’s something to be said for being close to the people you are going to do business with.”

Expects States to Persist
That’s why many tech companies, including start-ups, gravitate to Silicon Valley despite a high cost of living and other expenses higher than those offered through some incentive programs, Testa said.

Yet Testa expects state governments to continue to offer targeted tax breaks because they are much easier to get approved than across-the-board corporate tax cuts.

“It’s a lot easier to use a pistol than a shotgun,” Testa said.

Phil Britt ([email protected]) writes from South Holland, Illinois.

For more information …

“Growing Pennsylvania’s High-Tech Economy,” Greg LeRoy, Good Jobs First, January 2010: