Introduction [to State Enterprise Zone Programs]

We found that tax rate and incentive competition continued through the 1990s with no indication that this is producing convergence in effective tax rates among the states; the process resembles a game of leapfrog, with no state apparently content to be merely average.The most striking evidence of this is the prevalence, by 1998, of negative tax rates on new investment: not only does the construction of a new plant, and the generation of sales and income from it, fail to generate additional tax liability to the state in which the plant is located, but the plant actually reduces the firm's tax liability to that state in many instances because new-plant credits exceed the entire new-plant tax. Chapter 4: How Taxes and Incentives Favor One Industry over Another and Capital over LaborKnowing how incentives increase business profitability is clearly key to evaluating enterprise zones, but we also need to have a sense of the firm's likely behavioral response to incentives.Do enterprise zone incentives change the relative prices of capital and labor, and should we expect to see some substitution of labor for capital, or capital for labor?This is an important issue.We argue in Chapter 2 that the central justification of the enterprise zone idea is the creation of employment in targeted areas.If the incentives we use "cause" a firm to locate in our zone, but at the same time cheapen the cost of capital relative to labor, the employment-creating effects of the investment may be much smaller than they otherwise would have been.We found that 4 of our sample of 13 states provide, at the state level, a set of incentives to zone firms that clearly lowers the price of labor.Four other states have a clear capital bias.In the other 5 states, credits provide no clear reduction in labor or capital prices at the margin.When local incentives-property-tax abatements, primarily-are brought into the picture, however, the capital bias becomes much stronger.The possible effects of incentives on a firm's choice of technology, and the relative use of capital and labor in the production process, depend not on the dollar amount of incentives but on changes in the prices of capital and labor.The effects of labor incentives on the price of labor are quite small.In only two states does the average price reduction exceed 1.0 percent, and the maximum price reduction among the 16

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