New Business July 1, 2009, 7:54PM EST

Will Tax Breaks Boost Jobs?

States are doling out billions to woo companies and revive local economies. But their incentives may be undermining America's recovery plan

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With the economy slumping and unemployment approaching 10%, states are kicking corporate tax incentives into overdrive. In the past year they've doled out a record $50 billion to spur job growth. Cash-strapped locales are depending indirectly on federal aid to fund the tax-break bonanza.

But economists are beginning to wonder whether such initiatives create or save jobs at all. Companies taking advantage of lucrative tax incentives are jumping from state to state—and bringing their jobs with them. Sure, some states will see job gains, but they may be only temporary. As a result, the states' efforts likely won't improve the national jobs picture. The tax-break boom "undermines the economic union, and it misallocates resources," says Arthur J. Rolnick, senior vice-president and research director for the Federal Reserve Bank of Minneapolis. "It amounts to economic warfare among states."

How so? Consider the tug-of-war over General Motors. Officials in Michigan, Tennessee, and Wisconsin spent months trying to persuade the embattled automaker to locate a new small-car plant in their states. On June 26, GM picked Michigan. The clincher: some $44 million in incentives, including a 100% tax break on new equipment for 12 years. "From Day One, we said Michigan would aggressively fight for these jobs," Governor Jennifer M. Granholm said in a public statement.

Giving Away Revenue

But GM's decision won't improve the U.S. employment landscape. The carmaker is converting an existing plant in the state and keeping on some 1,200 workers but not hiring new ones. "Most of the time states are [just] giving away tax revenue," says Charles L. Ballard, a professor of economics at Michigan State University.

Tax incentives are nothing new. In a bid to boost their local economies, state officials often use financial means to persuade companies to relocate or expand existing operations. Today, they're offering a range of enticements, from grants for relocation costs and worker training to broad-based tax cuts. New Jersey lawmakers just passed an economic recovery package with a massive $1.5 billion in corporate tax breaks and other subsidies. Oregon gave Intel (INTC) $121 million to subsidize new chip plants in the state. Louisiana spent $358 million between 2006 and 2008 on tax credits for films, including $27 million for The Curious Case of Benjamin Button.

What's different now is that states are handing out an unprecedented amount of tax incentives at a time when they're living on the federal dole. States, which face a $166 billion budget shortfall this year, together are getting more than $416 billion in government aid. The money is part of the Economic Recovery Act, the $787 billion federal stimulus package designed to revive the U.S. economy and create jobs.

Under U.S. law, state governments can't allocate the funds to tax incentives. But given the states' budget holes, economists and policymakers fear federal money is going to pay for them indirectly. "When a cash-strapped state is giving out an enormous tax package and also getting federal money, the left hand, in this case the incentives, is connected to the right," says Greg LeRoy, head of Good Jobs First, a Washington (D.C.)-based nonprofit. Plus, states are ramping up the tax breaks just as many are slashing spending on health care and education—two areas the stimulus money is meant to protect.

State officials defend their tax initiatives, saying they have few other tools to boost jobs in the current economic malaise. "If you are working a campfire and you only have embers left, you better get some new kindling," says Jerold L. Zaro, who heads New Jersey's Office of Economic Growth. New Jersey policymakers, who currently offer small businesses $3,000 for each new job, credit the initiative with adding 17,000 jobs in the state.