This paper analyzes the potential impact of land capitalization on the incentive effects of enterprise zones, and their potential for being pursued by rent seeking landowners through the local public policy process. Enterprise zones have become one of the primary economic development tools and development-oriented interventions employed by state and local governments. Enterprise zone programs typically emphasize the provision of tax abatements to businesses locating or expanding within the economically depressed areas encompassed by the zones. The tax abatements are aimed at creating production cost and profit differentials between enterprise zone business operations and non-zone business operations. These differentials represent the incentive for businesses to locate or expand within the zones. The model presented in this paper suggests that enterprise zone tax abatements will succeed in increasing the utilization of targeted production inputs by zone businesses. The model also suggests that enterprise zones and enterprise zone tax abatements may lead to increases in land values that undo the cost/profit differentials generated by the tax abatements and diminish the incentive effects of the zones. Moreover, the capitalization effect may provide the impetus for rather perverse behavior. Landowners and public officials may seek to implement enterprise zones inappropriately, merely to contrive rents in the interest of landowners rather than to facilitate economic development in the interest of the community.

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CONTENTS

I. Introduction

II. The efficacy of enterprise zones

III. Property tax and public service capitalization

IV. A model of development incentive shifting

V. The policy and public choice implications of enterprise zone tax abatement shifting

VI. Conclusion

Endnotes

References

Enterprise zones represent one of the primary economic development tools employed by state and local governments as a means of targeting economic development incentives, especially tax abatements, to businesses operating in economically depressed areas. Enterprise zones are geographic areas that are designated by law for special policy treatment due to the economic conditions that exist within the zones. Presently, at least 40 states have laws authorizing the establishment of enterprise zones or some equivalent (1). In many instances, enterprise zones are designated and established pursuant to economic distress criteria specified in authorizing statutes or administrative regulations. An overview of enterprise zone designation criteria by Erickson and Friedman (1991) indicates that the distress criteria typically involve measures of area unemployment, poverty, and blight.

Enterprise zone programs tend to focus on the creation of production cost differentials that favor business operations situated in the enterprise zones over business operations situated outside of the enterprise zones. Although many financial and regulatory tools are available to create the desired cost differentials, enterprise zone programs in the United States have gravitated toward the provision of tax abatements as the primary means of cost reduction for businesses that operate in the zones. In particular, the tax abatements utilized in enterprise zones are typically aimed at subsidizing the purchase of capital and labor and providing an infusion of additional financial resources to businesses operating within the enterprise zones (2).

Given the reduction in tax cost, a business operating in an enterprise zone is expected to generate a larger profit margin than it would otherwise be expected to generate by operating outside of the enterprise zone. Moreover, the enterprise zone tax abatements are expected to increase the level of capital investment and employment undertaken by zone businesses. Overall, the relative advantage in terms of cost and profit that a business may experience by operating in an enterprise zone is expected to increase the level of business development within these economically distressed zones, and improve the economic opportunities available to the people residing in and around the zones. Consistent with Peterson (1981) and with Jud and Parkinson (1990), this represents a "public interest" explanation for the establishment and operation of enterprise zone programs (3). Local development policies like enterprise zones arise due to the community spirit of local political leaders -- the desire on the part of local political leaders to create employment opportunities for community residents and to maintain the community's fiscal capacity. Nevertheless, the effectiveness of enterprise zones in creating employment opportunities and spurring investment has varied. The following section contains a review of literature assessing the effectiveness of enterprise zone programs.