What government should want from economic development (wonkish)

I recently read a report written by a respected consulting firm in the Maritimes where it discussed the leverage ratio of government investment in a sector to the amount of GDP created.  It concluded the $100 million+ invested by government over x years had generated over $200 million in new GDP.  This was defined as a ‘leverage ratio’.  Every dollar of government investment generated more than $2 dollars in new GDP.

This is quite common, of course.  Tourism investment models will talk about the amount of new tourism sales generated as a result of government (read taxpayer) investment.   You will hear 5 or even 10 times as a leverage ratio.

But this is bogus.  I don’t care how much GDP is generated by government investment.  Nor do I care how much private investment was leveraged.  I don’t care how much new industry output or spending was generated because of a government investment.

The only leverage ratio that matters when the taxpayer is funding economic development is tax revenue.  For every tax dollar in, how much new tax revenue was generated?

The reason for this should be obvious.

If you are measuring GDP and you conclude that a great ratio is $3 in new GDP for every tax dollar invested, in theory you could double, triple or even increase your taxpayer investment by 10 fold.  Why not?  If that is a great return on investment ($3 per $1) why not go for broke?

Because a provincial government will only generate new tax revenue at between 8% to 17% of GDP or so depending on the sector.

Therefore, if government puts $100 million in to get $250 million in new GDP, it will only get between $20 million and $42 million new tax dollars or between 20 cents and 42 cents in new tax revenues for every dollar of tax revenue out the door.

In other words, a big negative return on the taxpayers investment.

I have said many times government investment in economic development must be tied to this kind of model.  When a government invests in health care, it gets health care.  Education, education, Roads, roads.

But what does it ‘get’ from its investment in economic development?  There is no tangible service.

If you are only measuring job creation, you could spend the taxpayers money willy nilly.  We created 1,000 jobs!  Never mind we spent a billion tax dollars to do so.  If you are measuring GDP or output, you get the same results.

Many of my colleagues in the economic development biz  disagree with me. They say all of the work they do has value beyond a simple tax measure.  I am told “if it wasn’t for us sector x would not be nearly as successful”.  But again, where’s the cap?  Using that logic why not plow triple the tax dollars into that sector?

At the end of the day if your ultimate measurement of economic development is “without us it would have been worse” that is not a very ambitious view of economic development.

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5 Responses to What government should want from economic development (wonkish)

  1. “The only leverage ratio that matters when the taxpayer is funding economic development is tax revenue. For every tax dollar in, how much new tax revenue was generated?”

    The argument is intuitively sound, but may run into difficulties in its depiction of increased tax revenue as a good. That is not to say that I am opposed to increased tax revenue (far from it), but in New Brunswick at least there is a feedback where increased tax revenue leads major employers to lobby (often successfully) in their newspapers for lower tax rates. The result is a reduced tax base that leaves the province vulnerable in the event of an economic downturn. Or, in other words: recent history.

    So what this argument needs is a mechanism for depicting taxation as a social good, as a desirable outcome of government policy, and not an unbearable load placed on business which serves no economic purpose whatsoever. Failing that, no amount of economic development whatsoever will lift New Brunswick out of its current exigency.

  2. David Upton says:

    I agree with your point about the government ROI on economic development investment, jobs aren’t the right thing to measure. I would, however, include direct cost savings to government in additional to tax revenue. If a government investment creates jobs for people who were in receipt of income support (welfare) then those savings should be used against the cost of the investment. Money the government doesn’t continue to spend is as valuable as new income.

    What do you think about savings and/or tax revenues that continue over a period of time in excess of a year? Should they be calculated?

    I enjoy your posts a great deal and, although I don’t always agree, have often been forced to examine my opinions pretty closely. Thanks!

  3. The reduction of spending elsewhere from economic development should be part of the mix although there are a number of government programs meant to help people transition from social assistance and those costs are also part of the calculation.

  4. My assumption is that the main reason for government to support economic development at all is to generate the tax revenues needed to support good quality public services and infrastructure.

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