By MICHAEL D. KLEMENS

Enterprise zones:
Do they work as economic development tools?

Enterprise zones have been a key element of state and local economic development efforts for nearly a decade. The Department of Commerce and Community Affairs (DCCA) says that between 1984 and 1990 companies located in enterprise zones invested $4.647 billion in buildings and equipment. Businesses in enterprise zones created 79,298 jobs while retaining another 151,953 jobs. The numbers claimed by DCCA are impressive, but a comprehensive study has called them into question.

The study entitled "Enterprise Zones in Illinois" was done for the Illinois Tax Foundation by Sangamon State University's Institute for Public Affairs. Researcher Kent D. Redfield found the program well-received by local officials but fundamentally changed from its original concept. When Redfield tried to determine whether benefits from economic development in enterprise zones outweighed costs, he concludes that there is too little data to make a determination.

The enterprise zone concept originated in England, where areas unfettered by government taxes and regulation were seen as a way to stimulate economic growth in older urban areas. Ronald Reagan seized upon the idea, and in the early 1980s there was promise of a federal program with federal tax breaks. The federal enterprise zone program has yet to materialize, but its promise spurred states, including Illinois, to adopt programs. Currently 37 states have some form of enterprise zones.

The original Illinois enterprise zone legislation called for designation of eight zones per year for six years. That number was increased, and the state has 88 zones today. Over the years the program has moved from a need-driven effort to one that is demand-driven, Redfield says. Enterprise zones are no longer located solely in distressed areas, and they were employed in the efforts that located Diamond Star Motors in Normal and Sears in Hoffman Estates.

The original 1982 program provided for a pair of state tax incentives for businesses that located or expanded operations in enterprise zones. The first was a state investment tax credit of .5 percent against the state income tax for investments in a zone. The second was a sales tax credit (later an exemption) on materials purchased locally for construction within a zone. To get a state exemption, local governments must grant a local exemption.

In 1985 three more state tax incentives were added: 1) a $500 per-new-hiree income tax credit, if five or more workers were hired and the workers were Job Training Partnership Act eligible (disadvantaged or displaced); 2) exemption from state utility taxes for businesses investing $5 million and creating 200 jobs or investing $20 million and retaining 1,000 jobs; 3) a sales tax exemption on materials and machinery used or consumed in manufacturing or in operating a pollution control facility, with thresholds of a $5 million investment that creates 200 jobs or a $40 million investment that retains 2,000 jobs. The third incentive was expanded in 1988 to include firms that invested $40 million and retained 90 percent of existing jobs.

The key local tax incentive is the promise of property tax abatements. Downstate such abatement must be offered by each taxing district (city, county, library board, school district, etc.). The abatements can be for all or part of the value added by new construction and need not be the same for each taxing district.

In Cook County the enterprise zone property tax break is part of the property tax classification system, which values different types of property at different rates for property tax purposes. Nonmanufacturing industrial property, typically wholesale or transportation companies) is assessed at 36 percent of value under the classification system. New, rehabilitated or previously abandoned nonmanufacturing facilities (wholesale or transportation companies) in enterprise zones are assessed at 16 percent for eight years and at 30 percent for four. The same assessment break is given manufacturers in new, rehabilitated or previously abandoned property anywhere in the county.

The study looked at eight enterprise zones, selected as typical of zones created in Illinois. Cook County zones included Chicago Zone I, Chicago Zone II, Cicero and Chicago Heights. Downstate zones were Decatur, Danville, Belvidere and Monmouth. The first phase consisted of interviews done with business persons located in zones, community leaders and zone administrators.

Based on those interviews the researchers concluded that outside of Chicago local officials considered enterprise zones a method of promoting overall development, not targeting blighted or distressed areas. Chicago still stressed the original enterprise zone concept of neighborhood revitalization, the study found.

Local officials told researchers they valued enterprise zones both for the incentives available and as a way of saying to business that they were willing to work for a strong business climate. Business owners and managers were generally positive about the zones.

The second phase of the study was a mail survey of owners and managers of businesses located within zones. The survey divided businesses into: noninvestors, those who rented facilities within a zone; "participating" investors who spent their own money and used program benefits; and "nonparticipating" investors who owned their own facilities but used no incentives. The

26/ August & September 1991/Illinois Issues

nonparticipating investors accounted for 38 percent of the businesses but spent only 16 percent of the money invested in zones.

ln the "nonparticipating investor" category, 45 percent were unaware that they were in a zone. Another 10 percent knew they were in an enterprise zone but did not know that meant that they could take advantage of tax incentives.

At the same time, among participating investors (those who use one or more incentives) there was a relatively high degree of lack of knowledge of other incentives: 46 percent of those receiving no property tax break were unaware of the benefit; 26 percent were unaware of sales tax exemptions; 63 percent of the investment credit; and 21 percent of the job tax credit.

Among the incentives utilized, the sales tax exemptions were the most popular, employed by 73 percent of participating investors. The survey also found 56 percent used property tax abatement, 34 percent used investment tax credits and 21 percent used job tax credits.

The second-phase survey asked business owners and managers to compare the influence of enterprise zone incentives with other factors when making decisions to locate a new facility or expand an existing one. The advantages offered by enterprise zones trailed economic conditions, cost of doing business, labor force characteristics and community characteristics as factors in both expansions and locations. The enterprise zone's most significant incentive was property tax abatement, followed by, in order, the investment tax credit, sales tax exemptions and the job tax credit, for both expansions and locations.

The final phase of the study attempted to analyze what impact the zones had on economic growth and how much it cost.

Downstate, the statistical study found no impact on overall employment or manufacturing employment

Researchers said a lack of data limited their conclusions: They could only hint at a relationship. For downstate, the study concluded that economic activity was stimulated by existing companies rather than new firms. In Cook County the new economic activity appeared to be split between new and existing businesses. Overall, the study determined that most new investments and new jobs came from existing manufacturing firms. New firms that invested money and created jobs were primarily transportation, storage and commercial companies.

Because most economic activity comes from existing businesses, the initial configuration of the zone will determine the types of economic activity. (A zone that includes commercial areas will show more commercial growth than one that does not.) The study also determined that the more economic activity that existed in a zone, the more activity that will take place.

As part of the impact analysis phase of the report, researchers conducted an econometric analysis designed to isolate the effect of enterprise zone designation. Downstate, the statistical study found no impact on overall employment or manufacturing employment. They did find that employment and earnings in transportation, storage and wholesale trade increased 20 percent more than would have been expected.

The results were similar for Cook County, with a positive impact only on transportation, storage and wholesale trade firms. Researchers noted such businesses are very mobile, that such businesses grew during the 1980s and that they have a need for investments in buildings.

Costs were even more difficult to assess than impact. Researchers said that lack of data required them to make assumptions in trying to assess the cost in lost tax revenue of enterprise zones. Their example was the Decatur zone, where they estimated costs at $18.7 million and investments at $126 million. Their difficulty was in saying what portion of those investments were made because of the zone and what portion would have been made anyway. Assuming that 20 percent of the investments occurred because of the zone yields $1 in tax costs for every $1.34 in investments. Attributing 10 percent of investments to the zone would yield 67 cents in investments for every $1 in tax costs.

Researchers also noted that there was a multiplier effect that must be considered and that an investment made in the zone and the new workers hired there would spur economic activity outside the zone. Their conclusion: "While the tax cost/investment ratio is probably in the neighborhood of one to one, the ratio of tax costs to total program benefits is probably more favorable."

The study concludes with a series of recommendations. First, the researchers recommend that no new zones be created and that the state decide whether the program should target specific areas or promote general growth.

Second, researchers suggest changes in tax incentives to assist smaller firms that do not have large capital facilities. Recommended are state tax credits for any employment increases, with simplification of current benefits for hiring displaced or disadvantaged workers.

Third, researchers suggest strengthening the marketing of the program so that local businesses know and understand the operation of the zone. They also suggest that the state provide more promotion and assistance in operating zones.

Fourth, researchers, calling the current program "a textbook example of how not to design an evaluation component for an economic development program" urge new data collection and reporting. The study said: Data on employment and equalized assessed value must be collected; measures of tax costs must be established; closings and layoffs must be reported; the state should pay for some of the increased costs of monitoring.

Fifth, researchers suggest that six to 10 zones, all with low economic activity, should be given "priority zone" designation. Special incentives should be applied. If economic activity increases, the link to the zones could be assumed; if none occurs, there would be no tax loss.

"Enterprise Zones in Illinois" is an attempt to measure the success of an economic development program. The study lacks the data to make absolute conclusions and, to its credit, does not pretend otherwise. Its documentation of the dearth of data demands reform.

August & September 1991/Illinois Issues/27