Governments are responsible for providing services to citizens while businesses are focused on maximizing profits. Governments also use incentives defined by an economic development policy to promote job creation, wage and compensation growth, environmental goals, housing stock creation, or tax base expansion. However, economic development projects also have the potential to carry substantial risk and uncertainty. As a result, governments must carefully select economic development opportunities that do the most to further public objectives, while also minimizing risk to the government. This entails an analysis of risk to allow decision-makers to judge whether the project should proceed under the proposed terms. It also includes evaluating data and assumptions behind the forecasted cost and benefit of economic development projects in order to determine how accurate and reliable the forecasts are. Finally, a government must evaluate which incentive tools might be best suited for the opportunity.
The Government Finance Officers Association (GFOA) recommends that government officials analyze the specific benefits, costs, and risks associated with economic development projects, programs, and policies as an integral part of selecting which projects, programs or polices to pursue. Below are key points to observe when assessing benefits, costs, and risks:
- Identify financial and non-financial benefits and costs. Economic development projects will create both financial and non-financial benefits and costs. Financial benefits and costs are those that will impact the government’s bottom line. For example, additional property tax revenue, payments made on the project, and maintenance expenditures will be reported on the government's operating statement. Non-financial benefits and costs, do not translate directly into revenues or expenditures for the government. For example, the quality of the natural environment, the community’s reputation, and traffic patterns could all be impacted by an economic develop project, but these impacts would not necessarily captured in a financial statement. However, an evaluation of an economic development project should still consider these non-financial impacts.
- Consider the timing of costs and benefits. Economic development projects and their impacts generally occur over multiple years. It is important to define the appropriate period when expected benefits and costs will occur to calculate the net benefit/cost for each year as well as a total net benefit/cost. When comparing benefits and/or costs from different years, it is important to discount future year impacts to compensate for the time value of money.
- Assess the chance that benefits or costs will occur. Projecting future benefits and costs of an economic development project involves some level of uncertainty. Not all project benefits/costs are guaranteed and this must be accounted for in the cost/benefit analysis. Uncertainty is often greater around future benefits such as future revenue streams or job creation. Governments should use analytical methods that reflect this uncertainty and the probability of the projected benefits and/or costs occurring.
- Consider multi-jurisdictional impacts. An economic development project has the potential to create benefits for overlapping and/or neighboring jurisdictions. These costs and benefits are highly relevant to the community that the government serves, so they should be considered in an analysis.
- Consider Growth and Diversification of a Jurisdiction’s Revenue Base. An analysis of project benefits should include items such as:
- Estimates of income, sales, property, and transactional taxes
- Thee impact of employment or income multipliers or other indirect economic effects
- Any additional demand for new or remodeled business properties as a result of economic activity and the ability for existing housing stock to accommodate new resident workers.
It is important that the revenue analysis measure the impacts from business displacement and the “new” revenue generated within a government rather than the result of business activity that is moved from one existing business to another.
- Consider opportunity costs. Evaluate other potential uses for the funds, land, and other incentives. This can also include one-time upfront developer subsidies. The evaluation should include uses discussed to date or that may develop in the future, recognizing that future uses inherently involve uncertainty. Is the considered project the highest and best use of the incentive(s)? Or, is it plausible that some other future project could generate sufficient benefits to justify the risk of passing on the project currently under consideration, even if a more desirable project won’t appear for some time?
- Ignore sunk costs. A cost-benefit analysis should only consider future costs (or benefits) and should not let money the government has already spent influence the analysis. This is because the goal of a cost-benefit analysis is to help a government maximize its net benefit going forward from the current period. Money that has already been spent should not be considered as part of calculating of future costs.
- Communicate results clearly. Finally, when presenting the results, the analysis should contain a clear description of the net impact for the jurisdiction, the constructed methodology, and the assumptions employed. It is important to acknowledge the strengths, weaknesses, and limitations of results so that decision makers are fully informed.
This best practice updates and replaces the following:
- Assessing Risk and Uncertainty in Economic Development Projects (9/2015)
- Evaluating and Managing Economic Development Incentives. (2/2014)
- Evaluating Data and Financial Assumptions in Development Proposals. (9/2013)