7 Cost-Benefit Principles for Economic Development
The following article originally appeared on LinkedIn and the seven principles underpin every aspect of our Impact DashBoard software.
Cost-benefit reports are ubiquitous in economic development but the quality and relevance of these reports vary significantly. The lack of an industry standard concerning terminology and presentation contribute to broad confusion and misinterpretation. In many cases a high-quality cost-benefit report will help all sides better understand the good and the bad of what may come with a planned project and bring to light issues requiring further study. However, in too many instances these potentially useful reports are intimidating, opaque, and ultimately abandoned in favor of “gut feel”. This article is intended to help economic developers, their boards, and other stakeholders cut through the jargon and identify the hallmarks of a high-quality cost-benefit report so that they can utilize the report to its fullest potential.
Before we get too far in to weeds, let’s first address the name of these analyses. People use a variety of names for more or less the same type of study. Names such as cost-benefit analysis, economic impact analysis, fiscal impact analysis, ROI report, or simply impact report are used almost interchangeably to describe a study that seeks to determine the value of the economic development project to a state or community. As the old adage goes, don’t judge a book by its cover. Likewise, don’t be influenced by the name of the report, dig deeper to make sure it addresses all or a good number of the items below.
1. Focus On YOUR Region
A municipality that receives a cost-benefit report prepared for the state will be able to gather a general understanding of the proposed project and comprehend the project’s impact on the state, but ultimately this report isn’t useful to the municipality.
The cost-benefit report should be explicit in defining the geographic region under analysis and that region should correspond to your organization’s purview. We generally see cost-benefit reports coming in two different flavors: state impact and local impact. State-level reports detail information relevant to the state economy and state taxes. Local reports focus on county, city, and school impacts. Depending on the purpose of the report, you may see an all-encompassing report that can satisfy the inquiries by state and local stakeholders.
2. Economic Impact Is Not One Number
Economic impact is a common element included in cost-benefit reports and understanding the jargon can help you digest the project under analysis. Economic impacts occur anytime money changes hands; whether it is from me purchasing tacos at a food truck, Ford purchasing aluminum to make trucks, or Google hiring a new developer. A common misconception is that there is a single value that represents economic impact. Economic impact is typically measured using four metrics; (1) employment, (2) household earnings, (3) economic output, and (4) value added. For a longer discussion and definitions see a post on our blog on this topic.
Many cost-benefit reports used by economic developers focus on a new business. Although a new business will generate an economic impact, the scale of that impact typically doesn’t warrant the use of economic output or value added. This is to say; these measures won’t provide any meaningful insight to the project. The easier-to-comprehend impacts of employment and household earnings are the most instructive measures to be included.
3. Understand Multipliers
If you have spent some time in economic development, then you’re probably familiar with the term and concept of an economic impact multiplier. I wrote in detail on this topic not too long ago but I’ll summarize the concept here. Multipliers are the “magic” behind calculating the economic impact. There are several types of multipliers but in their simplest form, direct-effect multipliers are values (something like 1.5 or 2.73) which are multiplied by the direct impact in order to determine the total impact inclusive of spin-off activity. So, if a company created 10 jobs and we knew the employment multiplier was 1.5, you would multiply 10*1.5=15 meaning 15 total jobs were created inclusive of 10 direct jobs and 5 spin-off jobs. Multipliers are specific to a region and an industry. Generally speaking, the larger the region analyzed, the large the multiplier. Manufacturers generally have a higher multiplier value than retailers or restaurants.
To clarify some jargon that just got thrown around, spin-off impacts represent the ripple effect of the new direct business. Indirect impacts are simply the supplier impacts that result from business-to-business spending. Induced impacts are the employee spending impacts that occur when employees of the direct or indirect businesses spend money at retailers, restaurants or anywhere else in the region.
4. Public Revenues vs. Public Costs
In addition to the economic benefits, a typical cost-benefit report will address the fiscal impact or the revenues and costs to governments. Government revenues typically include new taxes, fess, or charges for services. The report should include the most significant sources of revenue for governments. You probably already know these revenue sources without digging in to detailed financial reports. In the majority of communities around the country, property taxes represent the most significant source of local revenue. In Texas, local sales tax revenue provides another significant source of funding to municipalities. Ultimately, the cost-benefit report should consider how revenue sources may be affected and include all sources that may be relevant.
Potential government costs can be difficult to estimate, but disregarding these costs completely is disingenuous. When new business activity occurs in your community or new workers move in, you can be sure there will be an increase in public costs – even if those costs are limited to marginal public safety and education expenses. In addition to the increased cost of general government, a project may impose significant one-time costs to be incurred by local governments.
5. Detailed By Jurisdiction and Over Time
The economic benefits and fiscal net benefits will accrue over a period time and these benefits will be distributed with varying intensity across many levels of government. A comprehensive cost-benefit report should project out over a reasonable time horizon based on the phasing of the project and detail the impact by jurisdiction.
Time Horizon: A snapshot in time just won’t do. Economic development is a filmstrip not a photograph. The cost-benefit report should cover a number of years so that it is long enough to be comprehensive but not so long that it’s ridiculous. Ten years is a common length, although depending on the nature of the project and possible incentives, a longer analysis may be appropriate.
Anytime you analyze a stream of revenues and costs over a period of time it is important to consider the time value of money and use a discount rate to pull future streams of money back to the current time period. For more on this topic and help choosing a discount rate, see a post that I wrote a few years ago – still solid advice today.
By Jurisdiction: State and local taxes are the result of specific tax rates. Although a business might receive a single property tax bill at the end of the year, those taxes get split up by jurisdiction so the county, school, municipality, or possibly other taxing entities receive a share of that tax. Costs should be itemized by jurisdiction as well. One lump sum number for tax or fiscal impact won’t help state or local officials understand these benefits. The impact must be delineated by taxing jurisdiction based on specific tax rates, revenues, or attributable costs.
6. Inputs and Key Assumptions Available
A comprehensive cost-benefit report should be explicit about the inputs and key assumptions made in the analysis so the audience can understand what was analyzed and how it was analyzed. Cost-benefit reports combine three distinct sets of data: (1) project attributes, like jobs created and capital investment, (2) tax structure, like tax rates and jurisdictions, and (3) key assumptions, like property appreciation or depreciation, which enable the analyst to pull all of this together. You should be able to review all of the data going in to the cost-benefit report to ensure a reasonable approach was taken.
7. Incentives Analyzed
The impetus for many cost-benefit reports is the consideration of public support being proposed or requested. Cost-benefit reports should model the proposed economic development incentive by illustrating the value of the incentive and adjusting revenues that may be affected. For example, if the county considers a property tax exemption, the report should reduce the property tax revenue to be received by the county as expected by the length and percentage of the exemption proposed. In this way, the county will understand the value of this incentive and understand the net effect of this incentive on its revenues. Other incentives may be evaluated using an investment framework where a rate of return (ROI) and payback period are calculated to identify the point at which the government will break even on its investment. I’ve addressed the topic of incentive analysis quite a bit. For more info check out our blog or this video.