Research Shows Economic Incentives Crowd Out Start-up Businesses

Feb. 4, 2020

According to Good Jobs First, a nonprofit that tracks corporate subsidies, companies in Ohio have received $4.4 billion in local and state tax incentives since 1983. More than 10,000 awards have been made with a third of the sum going to 10 large corporations, including Amazon for local fulfillment and distribution centers built around the state.

With a surge in the amount of Ohio and national cities using income tax incentives, tax abatements, and infrastructure grants under the guise of attracting business and creating jobs, research that examines their efficacy in helping grow start-ups and further spur local economic growth is key for policy makers moving forward.  It is the type of research Mark Partridge, professor in The Ohio State University’s Department of Agricultural, Environmental, and Development Economics and C. Swank Chair in Rural-Urban Policy, receives funding to conduct.

With partial grant support from the Agriculture and Food Research Initiative, Partridge and fellow researchers from the Organization for Economic Co-Operation and Development, Ohio State, and Georgia State University set out to examine whether such incentives are worthwhile in the long-run or if they crowd existing business expansions and potential business start-ups that would have otherwise occurred without incentives to larger businesses.

The interdisciplinary and international research team employed data from the Panel Database on Business Incentives for Economic Development (Bartik, 2017) and the U.S. Census Bureau’s Business Information Tracking System to answer a primary question: are new business start-ups crowded out by incentives? And are small businesses and new businesses especially vulnerable because tax incentives and subsidies are typically aimed at larger firms (and existing firms)?

Their research suggests that, in contrast to their intended purpose, incentives crowd out new firms, and the crowding out effect is so large that it offsets any effect incentives might have in attracting new firms to U.S. counties. The findings have recently been accepted for publication in Economic Development Quarterly.

“We found that incentives have a statistically significant, negative relationship with start-up rates in total, in particular export-based industries and others that often receive incentives,” says Partridge.

Partridge further explains that after attracting a large company, local policymakers will be expected to cater to its wishes, which may diverge from the needs of new and small firms in the region. Thus, while incentive proponents argue that new firms and existing small and medium-sized enterprises benefit from the new economic activity, it very well could be that they are the biggest (net) losers if the incentives crowd out enough small firms, offsetting benefits from the incentivized firm’s input purchases from small firms as well as any other local purchases from the incentivized firm’s owners and workers.

Conversely, if incentives improve performance of firms that benefit from them (in terms of increased employment, higher productivity and/or other important metrics) and this improved performance outweighs the loss of economic activity resulting from crowding out as a result of incentives, the reported results are less discouraging.  Also, the net effect of incentives on local business start-ups is then critical to the current and future health of local economies.

Partridge adds that “however, economic theory and the existing evidence seem to suggest that this case is unlikely.”                    

Mark Partridge
The Ohio State University

Co-Author - Alexandra Tsvetkova
Spatial Productivity Lab, OECD Trento Centre for Local Development

Sydney Schreiner
The Ohio State University

Carlianne Elizabeth Patrick
Andrew Young School of Policy Studies
Georgia State University