When cities, counties or states offer large tax breaks to attract factories, corporate headquarters and other major facilities, the economic benefits may extend beyond the jobs and investment those companies bring. A new study suggests these incentives can also encourage innovation among other businesses in the surrounding community.

The study, co-authored by a University of California, Riverside scholar and published in the Journal of Accounting Research, examined large tax subsidy packages known as “Megadeals”. These incentives, valued at more than $50 million, may create conditions that help local companies and startups innovate by bringing skilled workers, technological expertise and new ideas into a region.

Researchers examined 115 Megadeals approved between 1990 and 2014. They measured innovation by analysing the number and value of patents filed by businesses in counties where the subsidies were awarded. Aruhn Venkat, assistant professor of accounting at UCR’s School of Business and a study co-author, said counties receiving Megadeals generally experienced increased patenting among local firms.

The researchers found that a substantial increase in the size of a subsidy was associated with approximately a 3.3% to 4.9% rise in patent filings by nearby companies. At the county level, this represented roughly two to three additional patents each year, suggesting that the arrival of a large company can have innovation effects extending beyond the subsidised business itself.

One explanation is the movement of skilled workers and knowledge between companies. Employees at technologically advanced businesses may eventually move to other local employers or establish their own companies, taking their experience and expertise with them. This can create “knowledge spillovers”, allowing ideas developed within one company to contribute to innovation elsewhere in the regional economy.

Tesla’s Nevada Gigafactory provides an example. In 2014, Nevada approved $1.3 billion in tax subsidies for Tesla, which subsequently built a $5 billion battery factory near Reno. Venkat noted that some former Tesla engineers later established businesses focused on recycling battery materials, applying knowledge and ideas related to recovering and reusing lithium from spent batteries. Similar spillovers could occur around other major technology companies as employees move between organisations or pursue entrepreneurial opportunities.

Workforce training associated with tax incentive agreements may spread knowledge further. Some agreements require subsidised companies to collaborate with community colleges on programmes that teach technical skills needed by the businesses. Not everyone receiving this training ultimately works for the subsidised company. Some may take their skills to other employers or start their own businesses, expanding the region’s pool of technically skilled workers and potentially creating a stronger environment for innovation.

The findings add another dimension to the debate over whether large corporate tax incentives provide sufficient public benefits to justify their costs. Venkat stressed that the research was not a comprehensive cost-benefit analysis and acknowledged that previous studies examining employment and business formation have often found limited benefits. However, he said innovation and workforce effects should also be considered when governments evaluate such subsidies. While these benefits do not occur after every Megadeal, the study suggests they appear, on average, across the incentives examined.

More information: Yoojin Lee et al, “Megadeal” Subsidies, Local Spillovers, and Corporate Innovation, Journal of Accounting Research. DOI: 10.1111/1475-679x.70079

Journal information: Journal of Accounting Research Provided by University of California – Riverside