Place-Based Fiscal Policies
October 24, 2019
According to traditional economy theory, there isn’t any need for placed-based fiscal policies. Regions that have better amenities, such as better government services or warmer weather, will pay lower wages and have higher prices while regions with poorer amenities will pay higher wages and have lower prices. In equilibrium, it is argued that people will move until everyone’s utility is equalized between the region with better amenities and the region with poorer amenities. In equilibrium, people would be indifferent between living in the two regions. However, in practice, a variety of factors, including moving costs and building restrictions in major cities, mean that people are often forced to continue living and working in disadvantaged regions of the country which struggle with low levels of productivity. These market imperfections are the rationale behind place-based policies. They can take the form of either capital or labor market interventions with different objectives and outcomes associated with each.
Capital market fiscal incentives try to address distressed areas’ low productivity by improving their access to capital. The largest example of this is the funding made available for the expansion of transportation infrastructure. At one point this was vital to the economic viability of a region, for example the expansion of the railroads in the West, on land provided by the federal government, created boom towns overnight. However, additional spending on infrastructure today doesn’t seem to create new economic opportunities as shown by the Appalachian Regional Commission’s lack of success with using transportation subsidies to improve the region’s fortunes. This result may be driven by the fact that better transportation infrastructure reduces trade costs between distressed regions and highly productive cities causing economic activity to relocate to major cities because high productivity producers are able to serve the distressed areas at a lower cost driving local producers out of business.
Another example of capital market interventions are subsidies for investments in low-income areas such as the federal New Market Tax Credit (NMTC). The NMTC program provides an income tax credit to an investor (typically a corporation) in return for an equity investment in a Community Development Entity which in turn provides loans and equity to businesses in low-income areas at lower rates and on more flexible terms than the market. This policy, passed in 2000, reflects a change in the Federal government’s regional development philosophy towards giving the private sector a greater role in the development of low-income communities. Evidence suggests that the policy is effective, but only has a small impact on the welfare of economically distressed communities. One important implication of both of these policies is that they change the type of business that locates in economically distressed communities, shifting it in towards more capital-intensive industries such manufacturing. This may be beneficial in the short term, as the availability manufacturing jobs is often beneficial for low-skilled workers. However, it also means that, because their output is tradable, their jobs are most susceptible to relocation when the capital subsidies are withdrawn.
The other category of place-based policies is labor market interventions. These policies attempt to directly increase labor demand in left-behind regions. The most significant of these policies are the federal and state enterprise (or empowerment) zones (EZs) which provide tax credits to businesses which locate and employ local workers in low-income areas. Indiana was the first state to utilize this designation in 1983, and in 1993 Congress empowered the Department of Housing and Urban Development (HUD) to select the first federal Empowerment Zones which where six major cities including Atlanta, Detroit, and New York City. The benefits of being in an Empowerment Zone for businesses were a tax credit of up to 20% for the first $15,000 of wages paid to a worker who lives in the enterprise zone. The evidence on state-level enterprise zones is mixed because there is so much variety in the incentives and requirements associated with each states’ zones. Yet, researchers find that federal Empowerment zones resulted in higher employment (a 12-21% increase) and wages in EZ neighborhoods (8-13% increase) without an associated increase in the cost of living. Another labor market intervention that has been in vogue recently is the relocation of public service jobs out of the capital and into other less-wealthy cities around the country. This policy began as a largely symbolic move, but recent research on this policy in the UK has shown that by moving government jobs out of London improved the economies of the recipient cities by directly increasing employment and boosting local business’ demand by increasing the number of higher-earning residents (Faggio 2019).
In conclusion, this brief overview of enacted capital and labor market-based fiscal policies shows that they can achieve, to varying degrees, increased employment, improved economic conditions, and reduced poverty. However, these policies are often expensive with estimates ranging from $20,000 and $100,000 per job created. Therefore, the potential for new ideas in this policy space remains very much open as governments look to be more effective. The broader question is which of these policies can create sustainable, long-term viability for these economically distressed regions even after the fiscal incentives are withdrawn. That question remains, for the most part, unanswered but its implications will continue to shape the way that place-based fiscal policies are implemented moving forward.
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