Step 2: What is the appropriate value of the incentive?
Once an economic development organization has determined that the business or project is worthy of an incentive offer, the organization must determine the appropriate value of the incentive. An appropriate incentive can only be determined once the economic and fiscal impact of the business or project has been estimated. Our website addresses the components of a comprehensive economic and fiscal impact analysis.
The firm or project will generate taxes and other revenues for the community and impose costs on various taxing authorities. The fiscal impact analysis will itemize the benefits, costs for each local taxing authority over a period of time. Assuming the project will result in positive net benefits, the incentive-granting organization should base the incentive offer on the net benefits to be received as a result of the project.
Incentives in the form of job grants can be viewed as an investment in the project. The flow of net benefits represent the return on this investment. Within this framework, an average annual rate of return can be calculated for a given incentive level. In addition, the length of the payback period can be estimated. The payback period is the number of years before the taxing authority is paid back.
Communities should only consider incentives with a rate of return greater than 10 years and a payback period of fewer than 10 years. Given the level of uncertainty surrounding economic development projects, communities may impose specific limits such as requiring a rate of return greater than 20% or a payback period shorter than the firm’s initial lease length.
Continue to follow our blog as we address proper discounting, uncertainty and evaluating other types of incentives or contact us to learn more about our customized impact models will help you protect public funds by using economic development incentives wisely.