Kentucky Economic Development: An analysis of incentive programs

John Stephens, B.A. and Heather Nett, B.A.Graduate students of Applied Economics, Western Kentucky University

(January 2012), ECON 598—Professor Bill Davis Ph.D.

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Abstract

The paper analyzes Kentucky incentive programs which are used to increase business

participation in the state. The paper used data from 4 different programs and 129 observations.

The research spanned from early 2001 to 2011. Each observation showed 1)the industry 2)the

county location 3) the project costs 4) the max tax incentive credits available for the project 5)

size of the loan grant 6) estimated new jobs created 7)the wage of the new jobs created 8) the

industry average wage. The main findings were inconclusive as measures of incentive programs

success, due to lack of data available. Tax information was not provided, leaving no measure to

see if the state recoups its initial investment. The Kentucky Economic Development Cabinet has

disregarded the need to follow up on the resulting number of jobs actually created, and only

recorded the projected amount of jobs to be created from the project. Compared to the industry

average, jobs created through incentives programs have a higher hourly wage. Majority of

incentives given were placed in the hands of manufacturing industry, which is not economically

optimal for Kentucky as research shows job growth in the long-run occurs in the Health and

Technology sectors. Previous studies have been plagued by the same lack of data. Starting in

2009, Kentucky has begun to acquiring an accurate cost benefit analysis for incentive programs.

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Introduction

Economic development is important for growth and the standard of living of a

community. Nations, states, counties, cities, and individuals are constantly competing with one

another to gain a competitive advantage and earn a higher standard of living than that of their

neighbors. Economic growth at its core relies on only a handful of indicators. Growth in human

capital, democracy, education, and growth in non-human capital are at the center of the research

(Barros, 1996). This is true for nations as well as smaller entities. Research has pointed to case

studies such as Germany in the second half of the 20th century, which had shown how lack of one

or more of these variables can be devastating.

Western nations in comparison are found to be very similar if not almost identical, when

comparing economic benefits. This fact induces the manufacturing of economic advantages, by

the creating of government incentive programs. Communities can invest in infrastructure such as

light rail. They can also promote education of its population giving tax credits to individuals to

attend schools. Some communities invest in social infrastructure like entertainment. These

investments make a community more attractive for businesses to either stay in a community or

move into a community (Gorin, 2007). These efforts began on the onset of the realization that

jobs seem to be leaving the United States at an alarming rate. With unemployment today is

calculated to be around 8.6% nationally and while this dismal, the real rate of unemployment is

much higher. By definition, real unemployment rate is the true rate of unemployment and by

default will always be higher than the unemployment rate. The difference is the addition of the

discouraged workers to the number of unemployed, unlike the total used in the simple

unemployment rate. The current figures show a 50% increase in the number of unemployed

when using the real rate method against the more common method that lacks pertinent

information, when attempting to get an accurate measurement of the current state of affairs. To

combat this problem, the pursuit is an attempt to try to gain competitive advantage over other

nations and other states by using incentive programs to lure new businesses into a community.

Governments also use these incentive programs to keep businesses from leaving an area.

This paper has three main goals. The first goal was to find an accurate measurement of

the true effectiveness of the past given incentives from the economic growth programs in

Kentucky. If the information was not available, the researchers propose alternatives so future

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evaluations could be completed. This paper shows that there is a lack of transparency when it

comes to this information. Kentucky is not different from most states, as it is unknown if the

government recoups its initial investment in a company through data measures such as tax

revenue to measure the effectiveness and efficiency of Kentucky’s economic incentive programs.

We can give general statistics about how much is spent per job created or how much each

industry has been invested in, but judging effectiveness cannot be determined due to lack of final

taxation data.

When comparing Kentucky to its neighbors economic competiveness of the current

incentive systems. We focused mainly on diversification of the industries that had already

received or are receiving incentives from these said programs. Once the total amount of money

given was divided into categories by industry and the percent of the total was calculated.

Kentucky’s discernment ratios was found to be lacking promising future, in that majority of

incentive recipients were located in the manufacturing industry. Research has found that the tech

industries are driving overall growth in the United States as majority of low tech manufacturing

jobs are moving to other countries with competitive advantage (Tech Journal South, 2011). The

Kentucky incentive program data shows that even though majority of jobs created have a higher

hourly wage than the industry average, communities most likely cannot recoup the loss incurred

by the initial investment in the company to come to the area (Eisinger, 1988).

Literature Review

Economic growth is a goal for communities to improve standard of living. Economic

Indicators and People Indicators can be used to summarize economic growth in communities

(Center for Business and Economic Research at Valdosta State University, 2011). In most

studies, unemployment rate is a measure of how the economy is doing. Most models ignore

economic freedom, which studies have shown have a direct effect on both predicting the poverty

rate and unemployment (Rhine, 2010). Poverty rate also has an effect on economic growth that

has also been used in most county reports, as increases in the poverty rate lead to more income

inequality and a change in the Gini Coefficient. Studies show that income inequality is harmful

for economic growth (Rajaram, 2009).

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Looking at a specific industry, manufacturing has had a major impact on economic

growth. In 1992, manufacturing in the United States was at 18.5% of GDP. In 2000,

manufacturing accounted for 17% of GDP, while in 2005 it was at 14.4% (Institute, 2007).

Exports have tended to decline recently, as more countries have chosen to import from areas that

are closer geographically (Coughlin, 2004). Staying competitive has become a growing

challenge that has required Kentucky to have more diversity when it comes to economic

development. One would expect to find the fall in GDP per capita to diverge from its current

trend, to a more favorable one. However, others argue that developed countries should rather

become ‘export specialists’ and use their competitive advantage as most goods in the economy

are exposed to global competition (Hesse, 2008). More competition would generate a higher

GDP per capita, but would expose those areas to heavy job losses when an industry fails.

Economies that are performing well usually have a larger then average percent of

business being owned and ran by the private sector. This is usually the effect of communities

with established private property laws and a set general rule of law, economic development is

then able to begin. In other cases when government gets too big, it begins to threaten economic

growth and is actually detrimental. In economies, education is one investment doesn’t plateau,

unlike a government. The more investment in education, the more possibilities open for

economic growth in the future (Barro, 1996).

Many believe that incentive programs are a failure. State and local combined

expenditures as of 1996 were as much as $48.8 billion (Thomas, 2000). This is not loss of tax

revenue, but rather payment made to businesses either through land gifts or credits. With such a

large sum of government money being spent it is advantages to answer the question: “Are the

incentive programs really working?” Research shows that majority of incentive programs do not

recoup their investment through taxes and therefore put the government at a loss (Eisinger,

1988).

When determining the value of an area, in regards to its future earnings potential: one

may begin by looking at what is legally even possible. Without the right to own, work, and be

equally compensated, economic development is almost impossible. And therefore, should

rightly be looked over as a possible area of investment for future gains. Much of the research has

also gone into economic freedom, a measure of how business friendly an area is. Economic

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freedom is a necessary condition for the creation and sustainability of civil and political

freedoms (Friedman, 1980). A clear rule of law protects everyone from restrictions of liberty, by

regulating markets better by allowing no one individual to have additional privileges. These

privileges can lead to imperfect markets and barriers to entry, leading to an inefficient market

(Harper, 2003). Contract rights also are included in this, as individuals should have the right to

make contracts with whomever they choose. These contracts cannot be thrown out once signed

either, as it’s also important to enforce the contracts to meet obligations by providing safe

passage of property from one individual to another (Orth, 1998).

Economic Freedom is rated in several indexes, and is most noted for two specific annual

surveys; Economic Freedom of the World and Index of Economic Freedom. The Economic

Freedom of the World, by the Frazier institute, and Index of Economic Freedom, by the Heritage

Foundation, rank the importance of several variables to Economic freedom. High average

income per person, higher income of the poorest 10%, longer life expectancy, higher literacy

rate, low infant mortality rate, higher access to water, and less corruption (Heritage Foundation,

2011). When determining the state level of the current Economic Freedom, this is measured by

another index using the same variables (Ruger, 2009).

As our research shows the state of Kentucky clearly ranks below majority of other states

when it comes to these indexes. In economic freedom, Kentucky in 2009 received the 33rd place

on the index, which was comparable to Ohio and Minnesota 31st and 32nd respectfully (Ruger,

2009). Kentucky receives this rating due high income tax and high corporate tax. Most other

states have either a high corporate tax or a high income tax, but not both; Indiana ranks 16th on

the scale, with a much more business friendly environment than that of Kentucky. This is

important, because there isn’t much other difference between Indiana and Kentucky besides the

public policies chosen by the government (Goff, 2009).

With the implementation of incentive programs, Kentucky continues to involve

government intervention into the private sector. Using incentives to lure business into the state

has the state selecting the companies that will succeed or fail, not the market. Recent research,

using data from states, indicate that lower taxes across the broad economy and the use of tax

incentives and financial assistance programs do not stimulate state economies. Entrepreneurship

was the greatest source of economic growth. Traditional Tax reduction and environmental

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policies had little effect on growth. Government efficiency and increasing competiveness were

the answers to creating economic growth (Goetz, 2010).

Goetz continues, tax incentives and financial assistance programs are negatively

correlated with employment growth. Also, the opportunity cost of the funds given to these

organizations is borne by other firms already in the market or households, either through higher

taxes, or limited government services. The programs increase income inequality and poverty in

the end. These identical downfalls can be found in the economic incentives programs going on

in Kentucky, as massive spending on incentive programs most likely leads to reduction in other

services like education, if taxes are not increased. (Goetz, 2010)

Kentucky Incentive programs

Incentive programs vary across states. Kentucky has 15 different programs to encourage

businesses to either remain in Kentucky or to relocate to the area. The programs are changing

constantly through legislation passed through the Kentucky House. In 2009, for example,

‘Incentives for the new Kentucky’ House Bill was passed. This bill created even more new

programs, highlighted by the first program to help small businesses (KCED, 2011).

Other programs other than incentives have been introduced. In August of 2011, Gov.

Beshear launched a program in conjunction with the Kentucky Workforce Investment Board

called ‘Kentucky Work Ready Communities,’ or KWRC. The Kentucky Workforce Investment

Board, which focuses on workforce development in the state of Kentucky, created certification at

the county level for marketing purposes, stating that communities have the talent to attract new

businesses to the area. KWRC will aid in marketing qualifying counties to attract new

investment. Kentucky, like other states, must compete to attract jobs to their communities. The

KWRC certification package has qualifiers for different readiness categories. KWRC works

differently from other government programs by pairing the government with specific businesses,

community organizers, and education leaders in the area. Local businesses, community

organizers, and education leaders have the task of creating and communicating goals. After

implementation, these groups must also edit targets to reach the goals created. Staying on course

to ensure the goal is reached in an acceptable period of time, even if new strategies must be

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implemented, this is a key aspect of the program. KWRC details that the county has enough

talent to staff existing jobs in the community and has capability to learn new technologies to go

along with innovation in technology heavy fields. The six specific areas of criteria are labor

intensive and used by numerous private organizations to evaluate a prospective new area to set

up a company. These criteria include high school graduation rates, NCRC certification

percentage, a measure of community commitment, higher educational attainment, a soft skill

program implementation, and some other supplement criteria (Richardson 2011).

The previous program is not a financial incentive. Never the less, it is a way Kentucky’s

government can regulate the private sector. The most used programs over the past decade will

be discussed in the following sections. The basic idea behind each program is to stimulate local

economic growth.

KEDFA

Kentucky has developed a complex and efficient structure of programs to expand the

already existing businesses along with new entries to the current market. The foundation of this

initiative, Kentucky’s growth programs, is the Kentucky Economic Development Finance

Authority direct loan program. This can be further referred to as the KEDFA. The major

offering is a mortgage loan plan to coincidence with private funding. After approval,

refinancing is prohibited also the terms and payments are left to be set by the private lender.

Authorized projects are thought of as optimistic long term investments, with the outcome of a

positive future for Kentucky’s economy. This money is limited to domestic intensive markets

only, such as: agribusiness, tourism, industrial ventures, and the service industry. This ensures

the largest possible benefit possible, given the investment, to the local tax payers, who initially

provided the money for the program and Kentucky as a whole (ADOR, 2011).

The KEDFA is structured as a declining percent of participation as incentive program, as

the total project cost increases. To explain by examples, project cost with the percent of KEDFA

participation: up to $200,000.00 (50%), $200,000.00 to $500,000.00 (40%), above $500,000.00

(30%). Further requirements must be met prior to acceptance to the program. Such as an

additional monetary requirement, of the proprietor of the applicant company is to personally

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provide a minimum of 10% of the cost of the fixed assets. In addition to the loans, grants are

also made available but with this addition arises extra conditions that must be met. For example

the total participation of the government is limited to not exceeding 33% of the project cost.

With this money only fixed assets such as land, building, and equipment may be financed

(SCED, 2011).

The requirements of the actual project are modest and not overly demanding when

compared to the program benefits. The endeavor must produce new jobs or ensure a meaningful

positive impact on Kentucky’s economic growth of the society at large. To further ensure the

integrity of the project, personal guarantees are required of all company owners who hold at least

20% of the company stock, along with a 4 month update is required to confirm the project is on

track (SCED, 2011).

The current interest rates and fees being charged are fixed and linked to the term of the

loan. Rates are as follows with the term length then the interest rate: 3yr (1%), 5yr (2%), 7yr

(3.5%), and 10yr (5%). Upon submission of the application, there is non-refundable application

fee of $500. Also a 1% commitment fee with a minimum amount of $1,000 is due within one

month of the date of approval. Only upon completion of the total project, which will be outlined

fully in the application, will these government disbursements or benefits begin (SCED, 2011).

To go through the loan process step by step: contact a private lender, KEDFA is

contacted to ensure eligibility and requirements, if qualified application will be submitted for

review and approval. KEDFA review staff makes the final decision. This program is the main

foundation for government supplemented enhancement of Kentucky’s economic development

(SCED, 2011).

KRA

When considering the location for a business, choosing the most cost effective and

profitable is crucial. This is the motivation behind the structuring of the Kentucky Reinvestment

Act (KRA). This program determines the eligibility for tax credits up to 100% on all corporate

income or limited liability company tax liability produced from the project at hand. Once

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accepted the company is given a window of time to redeem the incentives, a 10 year span

starting from the date of final approval. The companies that would be eligible for this program

must meet the following qualifications: planning a permanent or reasonable period of time to be

engaged in the manufacturing sector of Kentucky’s economy preceding the request for assistance

is needed and a minimum cost accumulation for the project at hand in the amount of $2,500,000

to be spent on eligible equipment and related expenses. A qualified expenditure would

encompass any money spent on qualified equipment’s associated costs. Such as the acquisition,

construction, new equipment which does include installation, restoration and enhancements to

presently owned equipment and facilities related to the project. Eligible restoration costs for

existing machinery are limited, prohibiting the use of expenses uncured from standard wear and

usage (KY press release, 2012).

For employment status of all human capital as of the date of preliminary approval, there

is an obligation to maintain at least an 85% full-time employee base at the facility. Furthermore

as for the past five years, prior to the submission of application, if the company was awarded any

incentives from the Kentucky Industrial Revitalization Act equates to automatic elimination of

eligibility for this program. Also the candidate is required to declare the project to be non-

feasible without the government incentives. The said incentives will be available only once the

total cost of the project reaches a minimum of $2,500,000 this amount may include eligible

expenses incurred from the training the current human capital, by an approved company in

relation with occupational training of full-time employees. Acceptable expenses related to

training are: costs for instructors whether they be current employees, contractors, or consultants,

the educational institution administrative costs, teaching materials, rental expenses, and the

wages paid to employees while attending the occupational training, while also including travel

(BLS, 2010).

These mentioned eligible costs only qualify if incurred after the preliminary approval

date through the date of the final approval. Of the total eligible amount spent on equipment and

related costs, up to 50% may be claimed. Unlike eligible costs accumulated from skills upgrade

training costs, up to 100% of the total may be claimed. Once the minimum cost requirement are

met along with 85% of the staff being at full-time employment status, only then can the final

approval go through. Upon the time of approval, begins the 10 year time clock countdown to

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take advantage of the given incentives which are clearly stated in the individual signed contracts.

At maximum, up to 20% of the total granted incentive may be realized per year. If this were

done consistence in consecutive years, it would take a total of 5 years at minimum to use up all

available credits (ADOR, 2011).

The step by step process for approval to this program begins with the company at hand

sending in an application to the, spoken about in the previous section the, KEDFA. The job

retention percentage and agreed upon expense amount are negotiated with the Cabinet and

presented to the KEDFA for their approval. If the KEDFA authorizes the applicant to be an

appropriate company for the program at hand they will give consent to continue the process.

This entails the two parties involved to enter into a memorandum of agreement that establishes

the maximum amount of incentives available and numerous other obligations. At this time the

company may begin the project. At the time, of completion the company will present all eligible

expenses with documentation before the KEDFA. The Reinvestment Agreement is then ready

for approval, if approved next the terms and conditions are then established. The terms and

conditions must be thoroughly agreed upon before the time of the concluding approval. When

all fees owed to the KEDFA must be disbursed. Throughout this process an independent

contractor may be used by the applicant, for the employment of known knowledge on approvable

expanses. Do note that this is a time sensitive process, there is only allotted a 3 year time span to

reach the final approval stage. Upon completion, the company is required yearly follow ups to

be given to ensure the company’s observance to the terms (SCED, 2011).

Fees associated with the process, that the company at hand is obligated to pay: first is a

non-refundable application fee due in the amount of $1000 with the submission of the KRA

application. Preceding the final approval, the company must pay for administrative costs that

were incurred by the KRA. These are limited to equaling to one-fourth of one percent or .25% of

the final KRA amount authorized in the contract. This amount can be up to $50,000. Lastly the

company is obligated to pick up all legal fees, containing also the necessary counsel expenses

encored by the KEDFA for the preparation of the contract (SCED, 2011).

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KIRA

Kentucky offers many incentive programs, offering each company the most tailored

incentives possible. The Kentucky Industrial Revitalization Act or otherwise known as the

KIRA, offers multiple incentive packages ranging from state level income tax credits, Kentucky

Corporate License Fee credits, to job valuation fees. Once approved there is a 10 year window

open to claim the incentives. The amount of incentives made available is calculated by using the

accumulated cost of restoring or constructing facilities and the renovation or buying of new

machinery and equipment (ADOR, 2011).

Characteristics a company must poses to be eligible for this program. New monetary

investments must be made in the restoration of manufacturing or agribusiness processes. In

companies that would have otherwise been in direct danger of permanent or temporary closure.

These efforts must have created or saved at minimum 25 jobs. For Kentucky coal mining

industry, there has been an exclusive clause written in to incorporate them into the tax incentive

program. Investments in the rehabilitation of treatment facilities that have been closed, whether

it is temporary or permanent, or just cut a large portion of the working positions. With this new

renovation must be anticipating being a minimum of 500 additional jobs must be added.

Additional production must reach a minimum of three million tons from the economic

revitalization project. All qualified companies possess these qualities, as well as more specific

characters revealed in the following paragraphs (SCED, 2011).

Upon approval of the local taxing jurisdiction, the company may impose a job appraisal

fee of up to 5% of the gross earnings on all jobs created or maintained by the project, whose

subject to paying Kentucky individual income tax. Will come to 5%, of this the state

contribution is restricted to 4% and local to 1%. Therefore, this incentive in short is a credit to

the worker’s state income taxes and the local occupational taxes. During this time, there is not to

be any harm done to the worker (SCED, 2011).

Starting the process of approval, an application must be submitted to the KEDFA along

with a local letter of support. In the application, a mandatory supplementary detailed description

of the company’s stats, encompassing the production area, reason for closure, and then ending

with a business proposal to continue if the incentives were received. The cabinet reviews the

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proposals details and determines the acceptable amount to propose. The KEDFA reserves the

right to preliminarily grant incentives and set the maximum amount available from the KIRA

given the individual circumstances, to confirm these incentives are genuinely preventing the

company from an otherwise inevitable closure. A consultant is hired at the company’s expense,

to investigate. A public hearing is held to obtain the public opinion on the matter. At this time an

approval is eminent, if eligible, from the KEDFA. The incentives’ availability takes immediate

effect upon final approval, with a 10 year window of availability to claim incentives. In addition

there is a five year period of time to complete the project and provide KEDFA with

documentation of the cost. The five year period is to start on the day of the final approval

(SCED, 2011).

Particular fees that are related to this process include a $500 non-refundable fee due

along with the submission of application to the KIRA. An administrative fee is required to be

paid upon final approval. This amount is limited to 1/10 of one percent of the final KIRA

amount authorized. Furthermore all basic legal fees acquired for the formulation of the

Revitalization Agreement must be repaid (SCED, 2011).

KEIA

The state of Kentucky has formulated an incentive program to inspire economic

development in already existing businesses that concentrate on: manufacturing, services,

technology, or tourism but excluding all retail sales ventures. This particular program is entitled

the Kentucky Enterprise Imitative Act (KEIA), which contains reimbursements of the sales and

use tax spent on all qualifying purchases (BLS, 2010). For a company to be deemed eligible for

the program a minimum asset purchase of $500,000 must have been made in an economic

development undertaking. Qualifying investment expenditures include money spend on

structures, building materials as well as electronics (with a required minimum of $50,000), R&D

costs, and for the purchase of new property. Note labor costs are not eligible as well as previous

costs incurred prior to the date of approval by the KEDFA (SKED, 2012).

Upon the KEDFA’s approval, the contract process initiated. All terms and conditions

must be agreed upon by the Cabinet preceding the KEDFA approval. The terms do contain a 7

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year grace period for extension if deemed necessary. Within the KEIA’s standard terms and

conditions there are set limits to the amount incentives available per company. On an annual

basis, the maximum sales and use tax reimbursement obtainable for building and supplies is set

at $20,000,000. While equipment employed for R&D, including electronics, is fixed to

$5,000,000 (SCED, 2011).

Required steps to complete the process are very comparable to the ones stated in the

preceding sections explaining other programs requirements. First an application given to

KEDFA is the first requirement, along with a projected timeline for the project’s completion.

Incentives package is then negotiated with the Cabinet. Then the plan is posed before KEDFA

for consent, wherein at this time the maximum amount of recovery is set, accompanied by terms

and conditions. At this time a 3 year window is opened to the company, to finalize the project

agreed upon. Upon completion of the project, the company must relinquish all necessary

information to the authorities. This program requires the company to make transactions directly

with the Department of Revenue, within 60 days of completion. The Department of Revenue

will be the issuers of the reimbursement, sales and use tax, again not surpassing the sum earlier

decided upon. Fee associated with this program are a $500 application fee owed to the KEIA at

the outset of the process (SCED, 2011).

KBI

A more particularized program has been developed that allows for a more extensive

period of time to realize the incentives. Look into that Kentucky Business Investment Program,

otherwise known as the KBI. The specifics, to be eligible for the program include any company

involved in manufacturing, agribusiness, regional/national control center, or technological

activities based companies. This program contains enhancements, put in place in hopes of truly

talking Kentucky’s economic problem areas on the county level. Such as, 1) if the average

unemployment level is higher than that of the states 2) if the unemployment level is 200 percent

above that of the statewide average for the preceding year 3) if the county is in the top 60 most

distressed county list (BLS, 2010).

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Minimum conditions that are to be met for eligibility to the program are as follows.

Generate or preserve a minimum 10 full-time jobs available to Kentucky residents. The wages

of these positions must be 125% of the current minimum wage for enhanced counties; non-

enhanced county’s wages must be 150%. These 10 said positions must come with the specific

employee benefits as well. Also the company is obligated to verify that this project would be

more profitable to go outside of Kentucky, if not granted the incentives (SCED, 2011).

An incurrence of eligible costs is a minimum of $100,000. Specific appropriate costs

comprise of 100% of the cost of the attainment of land, building, location development, as well

as startup costs. Then only 50% of all expenditures on rent for leased property for duration of

incentives. The incentives are available for up to 15 years in enhanced incentive countries, then

10 for the non-enhanced. This includes up to 100% of all corporate income tax liabilities

resulting from the project. In addition wage assessment incentives are available, 5% in enhanced

counties and 4% for non-enhanced. Additional terms and conditions must be stated in the

individual project contracts (ADOR, 2011).

The acceptance process begins with the submission of an application to the KEDFA. The

overall as well as annual incentives available, is negotiated with the Cabinet. It is then brought

back to the KEDFA for preliminary approval. The specific terms and conditions contract is

written up and agreed upon. The company is now free to begin the project. Once completed,

documentation is to be presented to the KEDFA. Final approval is given by the KEDFA. The

tax incentives are at this time activated for the recovery period, annual documentation must be

provided annually to prove continued compliance with signed contract. Fees that should be

noted throughout this process: a non-refundable application fee of $1,000, an administrative fee

due prior to final approval in the amount of 0.25% of the total incentives package given with a

maximum of $50,000, also all legal fees required for the formulation of the contract are to be

paid by the applicant company (SCED, 2011).

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The inner workings of Kentucky Incentive programs

Incentive programs in Kentucky can be categorized as ‘pay for performance’. The

programs look inefficient at first glance, as there is no magic number or mathematical formula to

evaluate a business, but it creates an environment that eliminates much inefficiency that plague

other state’s incentive programs. Kentucky incentive programs, being pay for performance,

never give out money to companies unless they can prove they created jobs and had the

opportunity to leave Kentucky if not having the incentive in place. This eliminates the need for a

claw back provision that many other states need to instate (Mandy Lambert, 2012).

The programs work in three phases. First companies will apply and get preliminary

approval. This portion is the data that will be used for the regression and analysis. Second, the

companies will finalize the proposal and begin the write up of an idea. Thirdly, the program is

activated and put to work. Finally, the programs are evaluated by the state and if goals are met,

incentives are paid out. This differs from other states, like Texas. Texas will actually pay out

incentives at the beginning to get a business interested in the area, making it necessary to input

claw back provisions into the contracts and taking on a large amount of risk compared to

Kentucky (DeFebbo, 2012).

Companies, in the proposal portion, must give a large amount of data to the state of

Kentucky. This included job projects, sales, profits, and investment into the project. The state of

Kentucky is interested in creating jobs with benefits, with using money from the business, not

the state. The incentive has the maximum potential of the investment made in the state of

Kentucky. The numbers are mainly based on state income tax liabilities (Mandy Lambert,

2012).

Approval must take place before any implementation occurs. If the company starts the

process of relocating, or even makes an announcement of impending move to the state of

Kentucky, they will lose the incentive contract. Projects usually span over 10 to 15 years, as

each year the company is audited to evaluate if the project is on schedule or not. An example, if

a company proposes creating 100 jobs over 10 years, then in year one, the company must create

10 jobs. 10% of the incentive is then paid out for that fiscal year after being confirmed through

audit. The incentive I not adjusted for inflation, so it is in the company’s best interest to create

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jobs as quickly as possible and receive the rewards. Kentucky will receive the projected taxable

income over the duration of the company operating in the state. When a company finishes its

proposal or overachieves, there are no added payouts, however if a company underachieves, they

will lose part of incentive proposal payout (DeFebbo, 2012).

Mentioned before, the KEDFA approve projects. This board, not politically elected but

politically appointed, meets monthly. These civilians are business and community leaders with

first-hand knowledge of the business sector. They approve a disproportionate amount of projects

for the manufacturing industry. Manufacturing companies create a higher multiplier than

companies from the service or retail industry. Manufacturing companies need to buy more

materials, and must construct more facilities to operate. These companies will bring in more

money into the area if a multiplier exists.

There is a difference between counties. Some counties are classified as regular counties.

These counties would include Jefferson County, Warren County, and other metropolis areas. If a

county is seen as a low performer, it is categorized as an enhanced county. The factors include

but are not limited to high unemployment, low wages and high poverty rate. Companies will get

a greater tax incentive for locating to enhanced areas.

Kentucky has an efficient system when it comes to paying, as little government waste is

seen from these interviews. Without data, one must question if the program truly operates in this

fashion. There is the opportunity for corruption without oversight.

17

Research analysis and data

Data shows effectiveness

of incentive programs is not

definable with the current model

or data. Simple statistics and spending habits of the government are the only data. As seen on

the graph, incentive credits far outpace loans and grants. Spending on incentive programs has

increased in the past two years enormously from just over $25 million in 2010 to close to $45

million in 2011. This could also be due to lack of data keeping by the KCED (Mandy Lambert,

2012). An increase in the amount of program applicants and participants is apparent. The first

few years of these programs, only one or two participants participated. In 2011, more than 60

companies participated in some form in the incentive programs. (KCED, 2011) As the number

of participating corporations has increased, so has the number of jobs projected to be created per

year. The latest numbers show over 4000 jobs are projected to be created from the 2011

packages offered to companies. When

analyzing the wage data, majority of the new

jobs created have a higher average wage than

the industry average.

When comparing the jobs created to the

industry average in Kentucky, there is evidence

indicating that these jobs gained through

incentive programs create jobs with a higher

average wage. However, it is unknown if these

higher wage jobs let the state recoup their

investment in the form of tax revenue or by some other means. Only in one year did the average

wage of the industry exceed that of the tax incentive recipients’ average wage. (BLS, 2010)

18

0500

10001500200025003000350040004500

70 43 260 6 17 225 71

12402122

4007

Jobs created

As for the individual industries, Kentucky seems to be focusing on the manufacturing

section. According to the census bureau, of the employed population in Kentucky 25% of them

are in manufacturing. The next largest is retain with 20% of the working population, finance

holds 6% of the jobs available, while information technology holds only 2% of the jobs (U.S.

Gov, 2002). These numbers reflect the percentages of incentives given, quite accurately. To

continue, research shows that growth industries are not in manufacturing, unless it comes to high

tech manufacturing (Thomas, 2000).

The amount of incentive funding that

the Kentucky’s state government is

willing to give up for a single job is in

the graph to the right. The average

marginal job cost under the heading

average shows a wide range as health

and finance industry jobs only take a

few hundred dollars to create on

average, while the manufacturing jobs cost $37,683 each to create. One can infer that there must

be a less of a need for manufacturing jobs as the wage per worker is almost the same ($32000 per

year) as the created job itself; $37,863 . Health care and tech services are the fast growing

industries and require workers to have a more

complex set of skills. Along with that, the

manufacturing industry in Kentucky does have the

problem of being semi-unionized, driving wages

higher. Through numerous studies, it is shown

that it is cheaper for companies to have jobs in

China and other corporate friendly areas where

wages are lower. In Kentucky, because wages are

so high, the price of the goods must also be

raised. This accounts for the increased incentive packages to balance the loss the companies are

taking by paying higher average wages.

19

20012002

20032005

20062007

20082009

20102011

010203040506070

2 3 1 1 18

313

33

62

Program Participants

Average Marginal Job costIncentives Jobs Average

Finance 128503 500 $ 257.01

Manufacturing 185739930.00492

9 $ 37,683.09Health 120013 505 $ 237.65Tech 4576000.00 514 $ 8,902.72Info 5177500.00 367 $ 14,107.63

Retail 16476112.00122

1 $ 13,493.95

Dissimilarity exists amid the average market wages against the incentive program

average wage for each market. Reference the Table 1 the Index the chart presents this material.

To note, finance is the only market were the market wage average above that of the incentives

program average, although we draw caution from this observation as only one occurrence from

finance sector obtained funding through incentive program grants. All other sectors are

significantly greater; the technology industry has a 101% higher expected wage if working a job

created by an incentive grant, the health care wages can be anticipated to be 89% higher than

market average, manufacturing is 70% above average, as well as information and retail are

around 15% above the market. As wages due to incentive programs are higher than the

industrial average, one must believe that less people are going to be employed, leading to higher

unemployment numbers in the state of Kentucky.

Variable Statistics and Regression

The researchers could do variance statistics on three of the variables (Table 2); total

project cost, estimated new jobs, and estimated hourly average wage. The findings show that for

total cost, there are several numbers that are close to modes, meaning that project approval and

the amount of funds given is an arbitrary number.

There seems to be little of a specific SWAT

analysis and therefore inefficient. For example,

at the $100,000 incentive mark, 7 companies

create between 20 and 87 jobs respectfully, while

the projects themselves cost between $4 million

and $55 million. Mathematically, there is no

relationship between the amount the projects will

cost, the number of jobs created, and the max

incentive given. The median shows over

$7,000,000 are the average investment. This can be a signal that most of the projects approved

are to bigger companies, and not startups. Research shows that growth in an economy is largely

fueled by entrepreneurship, and would not promote majority of grants given to already

20

Year New Jobs Wage Industry Wage2001 16.06$ 9.36$ 2002 14.18$ 9.38$ 2003 23.39$ 10.24$ 2005 20.93$ 9.64$ 2006 28.87$ 11.07$ 2007 11.07$ 12.07$ 2008 17.16$ 16.45$ 2009 16.14$ 12.28$ 2010 17.95$ 12.50$ 2011 17.42$ 12.44$

established companies. There is also a large range in incentive deals, as well as heavy pull

towards the left. There seems to be many small grants given, although the amount given doesn’t

seem to have much of a relationship to the number of jobs created.

The estimated jobs projected range from the creation of 1 job, to the creation of 923

through incentive grants. The average number of jobs created through each program approval is

66 and the median of this number is 35. This shows there is heavy skewness towards the

creation of fewer jobs in each approval. The wages of these jobs show a similar graphical shape.

Wages range from $7 per hour to $38.50 per hour. The mean (418 per hour) is higher than the

median ($16.50), showing skewness down. All three statistics have a relatively high sample

variance. Job creation does not seem to be focused on high or low wage jobs, but rather just the

creation of any job. As previously discussed, majority of the jobs created have higher wages as

those of the industry average of Kentucky.

The regression to define the correlation of the variables was implemented. A regression

was used to prove that there would be a correlation between how many jobs were created with

the amount the government gave for a tax incentive grant. It also seemed plausible the

regression should show that there would be a high relationship between the numbers of jobs

created with the higher wage of the jobs created. There is a difference between the

manufacturing, tech, healthcare, and retail industries. Using manufacturing as the base, dummy

variables showed differences between industries.

γnew job created=α +βTotal Project cost+ βAvg Hourly Wage+βMax Incentive

+ βRetail Dummy+βTech Dummy+ βHealth Dummy+ε

The hypothesized variable signs should show that has total project cost and max incentive

increase, the number of jobs created from the project would also increase. Manufacturing is the

least efficient market, whereby all the other sectors should have an increase in jobs created.

Average hourly wage had no hypothesis as the increase of hourly wage creates more

unemployment, but the higher wage also increases the number of participants in the labor force

21

willing to take the job. Each hypothesis sign proved to be correct, as increases of each variable

led to an increase in the number of new jobs created, with the exception of the retail variable.

When running the regression (table 3), and setting the number of jobs projected to be

created as the dependent variable, it can be seen that the amount of funding allocated through tax

incentives are important, as well as the project cost of the job. Manufacturing was left as the

base model, and all the other industry dummies proved to not be statistically significant. The

interpretation of the project cost variable, as the total project cost increase by less than one

dollar, the amount of jobs created should increase by one. The interpretation of average hourly

wage, as average hourly wage increases by $0.27, the number of jobs increases by one for the

project. Hourly wage is increasing when it should be decreasing for job creation, and the

variable was no statistically

significant in this regression.

The direction of the dummy

variables is correct by theory, as

higher output of jobs created through

the tech and health industry

compared to manufacturing.

Manufacturing is not as in demand

as the high tech sectors and therefore

has a premium price attached to creation of those jobs. It did not matter the hourly wage of the

jobs created. As stated before, the data shows that creation of jobs and not necessarily how

much the job pays seems to be the important part to the government when approving incentive

money allocation. There is omitted variable bias in the model, as variables that by theory would

prove to be significant are found to be insignificant. Also, the model only explains about 20% of

the variation in the dependent variable, meaning that there are other models that would better

explain the variation in the amount of jobs created through the allocation of funds of incentive

programs. There needs to be a lot more information and addition variables for this regression

technique to be used for incentive programs for the state of Kentucky.

22

0100

200300

400500

600700

800900

10000.00

5000000.0010000000.0015000000.0020000000.0025000000.0030000000.0035000000.00

Incentive vs job creation

Jobs created

Ince

ntive

s pai

d ou

t

Checking for multicollinearity in the data using a VIF score proved that there was no

such occurrence of this problem. The Durbin-Watson test was used to test for serial correlation,

which did occur in the data. This was likely from the variance statistics as there was a heavy

skew. This was corrected for using a Yule-Walker regression. The researchers lastly checked

for heteroskedasticity, which found no occurrence. This information can be found at the end,

under table 4.

Conclusion

The state of Kentucky has posed questions to the community and the research can answer

a few. When asked about jobs vs. incentives, the research shows that each job created through

incentive programs costs $26,408 per job created. The average yearly wage of the jobs created

was $38,625 which outpaced the industry average.

Incentive programs do create higher paying jobs than the industry average. To evaluate if

incentive programs ‘work’ is hard to quantify. To create higher wage jobs, incentive programs

do work. With these higher wages, one can assume that unemployment will rise, as employees

reservation wage will grow higher. The question of how are these programs financed and finally

paid for can’t be concluded with the data given. Incentive programs have been growing

exponentially in the state of Kentucky over the past 10 years as the number of participants in

incentive grants has grown from 2 in 2001 to 8 in 2007 to 62 in 2011. Incentive programs focus

has been on manufacturing as 75 of the 107 approved programs went into manufacturing.

Manufacturing was the only industry that the average yearly wage was less than the average cost

per job created. Any other industry would create higher paying jobs while having fewer

incentives financially.

Today, the government is asking for oversight and has asked questions to create an

evaluation process. The data that could be obtained is limited at this point as the incentive

programs do not offer transparency with their finances. With limited data, few conclusions could

be made specifically about the amount of funding that should be distributed through incentive

programs. There needs to be information involving tax revenue or some other mechanism for the

Kentucky government to recoup its investment through the incentive programs and if just

23

becoming available (Mandy Lambert, 2012). It can be said through interviews, that claw back

provisions are unnecessary at this point because Kentucky works on a pay for performance basis.

Kentucky also does not have much government waste in the form of upfront spending; however

might spend too much when it comes to each job created. Overall, an interesting subject that

points to an enormous lack of final data. Further research will need to take place in the

following years after data has been obtained through new measures implemented by the KCED.

24

INDEX

Table 1

Finance OBS Mkt-F % diff Manufacturing OBS Mkt-M % diff2001 - - - - 33394.40 2 21538 -2002 - - - - 45822.40 1 19989 -2003 - - - - 48651.20 1 21299 -2005 - - - - - - - -2006 - - - - 60049.60 1 23026 -2007 - - - - 21637.20 4 23421 -2008 - - - - 37450.40 3 26028 -2009 - - - - 35934.60 9 25796 -2010 24294.4 1 25376 - 39302.90 16 24714 -2011 - - - - 39280.96 60 26043 -Average 24294 1 25376 -4.26 40169 37 23539 70.65

Health OBS Mkt-H % diff Tech OBS Mkt-T % diff2001 - - - - - - - -2002 23732.8 1 17700.80 - - - - -2003 - - - - - - - -2005 43534.4 1 20051.20 - - - - -2006 - - - - - - - -2007 - - - - - - - -2008 - - - - - - - -2009 41943.2 11 25355.20 - 65187.2 1 29328.00 -2010 54121.6 1 23628.80 - 63973.867 3 26644.80 -2011 46515.73 3 23843.73 - 35332.267 3 25833.60 -Average 41970 14 22115.95 89.77 54831 4 27268.80 101.08

Info OBS Mkt-I % diff Retail OBS Mkt-R % diff2001 - - - - - - - -2002 - - - - 18928 1 20862.40 -2003 - - - - - - - -2005 - - - - - - - -2006 - - - - - - - -2007 24918.4 3 24564.80 - 23878.4 3 24752.00 -2008 - - - - 32177.6 1 26312.00 -2009 - - - - - 1 28329.60 -2010 31803.2 1 24232.00 - 37606.4 11 26281.75 -2011 29452.8 3 26540.80 - 36314.72 9 27547.52 -Average 28725 4 25112.53 14.38 29781 17 25680.88 15.97

Average Market Wage vs. Incentive Program Average Wage

25

Table 2 Project Cost New Jobs New Hourly Wage

Mean 19844355.07 65.99159664 18.23470588Standard Error 3156812.882 10.13298202 0.659292098Median 7225000 35 16.5Mode 4500000 15 11.6Standard Deviation 34436762.93 110.5377837 7.192027698Sample Variance 1.18589E+15 12218.60162 51.72526241Kurtosis 13.00198981 32.70741304 0.441451597Skewness 3.391689259 5.021022569 0.966786007Range 196405303 922 31.5Minimum 100000 1 7Maximum 196505303 923 38.5Sum 2361478253 7853 2169.93Count 119 119 119

SUMMARY OUTPUT : Table 3

Regression StatisticsMultiple R 0.456901364R Square 0.208758856Adjusted R Square 0.160804847Standard Error 105.8110334Observations 106

ANOVAdf SS MS F Significance F

Regression 6 292437.5609 48739.59348 4.353313968 0.000608888Residual 99 1108401.505 11195.9748Total 105 1400839.066

Coefficients Standard Error t Stat P-valueIntercept 36.76046756 31.04522575 1.184094065 0.239210995Tot_Prj_Cst 6.59999E-07 3.06869E-07 2.150750457 0.033930065Est_Ave_Hrly_Wg 0.27795002 1.557555022 0.178452778 0.858732074Max_Tax_Inctv 9.45516E-06 2.71602E-06 3.481256322 0.000744074Retail -8.922045916 27.43831933 -0.325167362 0.745740592Tech 15.53506078 43.41307153 0.357842931 0.721222669Health 16.50587549 45.42896386 0.363333743 0.717130264

26

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