Abstract
This paper examines how offering tax incentives in a local area affects the entry of new business establishments. We use the federal Empowerment Zone (EZ) program as a natural experiment to test this relationship. Using instrumental variables estimation, we find that the EZ wage tax credit is responsible for attracting about 2.2 new establishments per 1,000 existing establishments, or a total of 20 new establishments in EZ areas. New establishment growth is strongest in the retail (about 40 new establishments) and service (about five new establishments) sectors, and offset by declines or slower growth in other industries. Countless state and local governments offer a myriad of tax incentives in an attempt to lure new business establishments into locating in their jurisdiction. These incentives include a range of tax credits for investment in capital, job creation, research and de- velopment, and rehabilitation of structures. 1 Often, policy makers create incentives with the hope that they attract new establishments that become a catalyst for future economic growth. There are two primary challenges that arise in any attempt to determine the effect policy has on the location decisions of new business establishments. 2 First, policy is typically created for a single city or state, making it difficult to find a proper comparison group to construct a counterfactual for what would have happened in the absence of policy. Second, law-makers often craft policy in an attempt to either strengthen the local economy or change historic economic fortunes; therefore, incentives are a function of the current local economic situation, and the policies are endogenous to outcome measures of interest. These challenges often leave researchers with limited ability to identify the effects of offering tax incentives on new establishment location, as standard methods do not separate trends in the local economy from the policy effects or may give biased results due
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