By MARK LAUBACHER and WOODS BOWMAN

Illinois business: charity begins at home

Illinois' economy continues to falter in the face of increased business closings and rising unemployment. Until recently, this depressed state of affairs has been blamed on the state's high unemployment taxes, its lack of adequate tax breaks and its lousy weather. Recent research, however, indicates that climate and taxes have only minimal impact on a business' siting decision. The following article looks at Illinois' present tax break approach to business development and offers some alternative approaches

FUNDAMENTAL structural shifts in the U.S. economy have reduced the growth potential of the Midwest region. In an attempt to stimulate employment growth, Illinois offers business incentives, including several tax breaks and other financial benefits. The effectiveness of the tax incentives is dubious. Companies leaving Illinois for other states account for only a small portion of employment decline, while new business formations and the expansion of existing firms account for over 95 percent of Illinois employment growth. These facts suggest an industrial development strategy based on nurturing new and developing companies, rather than trying to lure firms away from other states.

Such a strategy should include several components: a one-stop ombudsman agency within the state government to assist companies with site selection, financing and cutting red tape; a highly aggressive loan and loan guarantee program for small and infant companies; and for cities, a comprehensive file of vacant sites that have potential for industrial expansion.

Business development

Illinois is caught between two long-term shifts in the national economic structure. Major technological changes have created several growth industries which are not prominent in its economy: electronics, chemicals and plastics. Other technological changes have reduced the labor requirements of important Illinois industries: steel, food processing and metal products. As these long-term trends continue, manufacturing states like Illinois face reduced employment growth prospects while other regions of the country maintain increasing employment growth, according to Interstate Tax Competition, published in 1978 by the Advisory Commission on Intergovernmental Relations (ACIR).

The idea that the Manufacturing Belt of states in the Northeast and Midwest is losing plants to the South and West exaggerates reality. While it is true that more new industries are locating in the South and West, and more Manufacturing Belt companies are locking their gates, this does not imply that firms are leaving the North wholesale to locate in the sunshine. Migration is a small portion of employment loss. According to a recent study by the First National Bank of Chicago, only 7 percent of Illinois manufacturing job losses were due to out-migration. Furthermore, a Commonwealth Edison study found that out of 4,014 closing plants in a 22-month period, only seven were relocating outside Illinois.

Nationwide, from a 1969 base of 140,093 major manufacturing establishments (employing over 20 perssons), only 554 establishments existing in 1976 were located in different states than in 1969, according to the ACIR study. The migration of firms from Illinois to the South may be the least important factor of employment loss.

If migration does not account for different growth rates between regions, what does? Researchers at MIT, including David Birch, have discovered that "every area of the United States seems to lose jobs at the same rate [both through closures and relocations] regardless of how rapidly the net job pool is expanding or contracting." The difference is that rapidly growing areas replace lost jobs at "two or three times" the rate of the declining ones, according to Birch in his article, "Who Creates Jobs?" published last fall in The Public Interest.

In Illinois the expansion of existing businesses accounted for 61 percent of new manufacturing jobs and the creation of new firms accounted for 36 percent, according to the May 1980 Illinois Legislative Council report, Ohio Business Incentive Program. Nationwide, there were 35,988 new manufacturing establishment formations in the period of 1969-1976, which created almost four million jobs, according to ACIR's study.

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These data suggest a policy of nurturing new and existing businesses within the state's borders rather than trying to lure plants from other states with tax incentives. Observers recommending this policy include the Illinois Legislative Council, ACIR, and Roger W. Schmenner for the Economic Development Administration in The Manufacturing Location Decision, published in March 1978. "It is best to satisfy the needs of smaller home-grown plants nth the expectation that a few of them will grow quickly and effectively," says Schmenner. Such a policy would also place a lesser burden on the public treasury than universal tax incentives which also subsidize many healthy, highly competitive firms.

Industrial assistance

When the Illinois Legislative Council compared the business incentive programs of Illinois and Ohio in its study, it concluded the aggressiveness of the Ohio financial assistance program seemed to explain the success of the Ohio economic development agency. The Illinois Industrial Development Authority (IIDA) approved $454,000 indirect loans in 1979, compared to J12 million in direct loans to "future oriented companies" in 1978 and 1979 by Ohio's finance authority.

HDA's direct loan program provides needed equity for small firms and is used to leverage other financing. In addition to this program IIDA also is in the industrial revenue bond business. Last fiscal year IIDA helped 16 companies borrow over $70 million through these low-interest bonds. To be able to benefit from this program, however, a company has to be rather large.

There is nothing wrong with helping large firms to locate in Illinois, but research at MIT has shown that small firms have the greatest growth potential. In normal economic times over three-quarters of all new jobs are created in firms employing fewer than 50 people, according to Birch. During recessions it is the small firms that are the most vulnerable and it is their potential (or creating jobs that is seriously undermined.

Expanding the direct loan program would most help small firms. Further assistance could be provided by loan guarantees. The Task Force on the Future of Illinois made such a recommendation two years ago and its words have not yet been heeded. Loan guarantees would have the additional advantage of being used during a recession to help a struggling new firm survive the worst.

Schmenner discovered that the overwhelming reason cited by companies for relocating outside most cities is the lack of necessary space for expansion. To retain its industrial base, a city must become active in land assembly. Cities must identify growing companies through direct contact and be ready with comprehensive information on available industrial sites. With this information, the city can match expanding firms with available sites. The Chicago Tribune reported last May that Chicago's Economic Development Commission (EDC) has no record of vacant industrial land, while the Boston Economic Industrial Corporation has a "file of available, industrial zoned land, together with details on its cost, ownership, tax status, sewers and other necessary data." Cities can also make careful use of eminent domain powers to permit worthwhile expansion of existing industries.

Chicago has an additional industrial development problem: fear of crime. A survey of Chicago manufacturers revealed fear for personal safety as their No. 1 concern. This fear is closely associated with poor perceptions of a site's other characteristics. To combat such fears supplemental police patrols could be assigned to designated industrial zones targeted for their development potential.

Futility of tax incentives

According to the ACIR's Interstate Tax Competition, regional differences in construction, energy and labor costs are generally too large to be outweighed by any differences in state or local taxes. Results from extensive surveys conducted by Schmenner in Cincinnati and New England "indicate that only about a quarter to a third of relocating plants move to new locations with lower property tax rates. The bulk, 40%-50%, move to locations with similar tax rates. Another quarter move to jurisdictions with higher tax rates. These results are not significantly different than what pure chance would suggest."

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Joel Kerstetter, writing for Chicago's EDC, says, "... taxes are usually a secondary consideration in the business location decision." He continues in the same report to say "as a practical matter, I have never encountered a firm that was 'driven from the city' by high property taxes."

The effect of any differentials in state and local taxes is halved because state and local taxes are deductible from federal taxes and the federal income tax for most corporations is 48 percent.

Generally the reports on the effect of tax incentives on industrial location concur; taxes are a minor or secondary consideration in the location decision. Investigators sharing this conclusion include: the Chicago EDC, Schmenner, ACIR, Andrew J. Aulde (The Effectiveness of State and Local Industrial Development Incentive Mechanisms, published by the Program in Urban and Regional Studies, Cornell University, August 1980) and John Rees (Government Policy and Industrial Location in the US, prepared for the Special Study on Economic Change, Joint Economic Committee of Congress, December 1980).

Costs of Illinois' approach

Naturally, some studies disagree with this conclusion. For example, taxes were found to be an important factor in location decisions in a "supply side" staff study prepared for the Joint Economic Committee last October and in a Harris Economic Research study by Robert J. Genetski and Young D. Chin in 1979. Neither of these studies, however, surveyed decision makers; instead, they were based on statistical models which are vulnerable to random error and related problems.

Some supporters of tax incentives to businesses suggest their real value is the signal they give that government is willing to cooperate with business.

However, Schmenner's study showed only 15 percent of all companies relocating in New England received tax breaks while 40 percent described their dealings with the public sector as highly attentive. This evidence clearly indicates that devices other than tax concessions can signal government's cooperation with business.

The worst feature of Illinois' current tax incentive program is that it makes no differentiation between growth and nongrowth industries. As a result it is far more costly than the benefits it generates. Tax programs should be concerned with attracting expanding industries which will produce more jobs with time.

We should keep in mind that tax incentives also damage government's revenue generating capacity. This hurts programs. Public programs which improve the quality of life are also of keen interest to firms seeking a new location. A 1976 study prepared for the Illinois State Chamber of Commerce (ISCC) showed education expenditures were positively associated with economic growth. A study on the business climate of the various states released this year by a consultant to the Conference of State Manufacturers' Associations (listing Illinois near the bottom) was criticized by Lester Brann, president of the ISCC, because it failed to give enough emphasis to the level of government services provided.

From almost all recent studies, tax incentives are ineffective in altering industrial location patterns and thus should not be the cornerstone of Illinois industrial development policy. We should not care whether other states offer more attractive tax incentives. Illinois has the basic economic advantages that are critical to long-run economic success. If the state fails to capitalize on its fundamental economic advantages and fails to address its fundamental economic difficulties, a politically popular program of "tax incentives" will simply reduce public revenue and create none of the hoped for gains in productive capacity or employment. □

Mark Laubacher is a student at Northwestern University and an intern to state Rep. Woods Bowman (D., Chicago). Bowman holds a Ph.D. in economics and is a member of the Illinois Economic and Fiscal Commission.

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