The ROTI Analysis For Economic Development
David Campbell is a Moncton-based economic development consultant and co-host of the Huddle podcast, Insights. The following piece was originally published on his blog, It’s the Economy, Stupid!, on Substack.
I saw an advertisement for an upcoming NB-IRDT online course: Introduction to Cost Benefit Analysis presented by Dr. Herb Emery, Vaughan Chair in Regional Economics at UNB. Knowing a bit about Emery’s thinking in this area, I suspect this will be a worthwhile investment of time for anyone interested.
Quite a while ago, maybe 15 years or so, I came up with my own take on this topic specific to economic development. I called it ROTI (return on taxpayer investment). I know in French it means ‘roast,’ so I’m not sure it has the same zing for folks in New Brunswick.
Basically, the idea was that government invests a pile of money into economic development and has limited ideas what works and what doesn’t. There were (and are) lots of metrics — activity-based (such as clients served) and outcomes-based (such as jobs created and investments made) — but the concept of the ROTI was to base results on the common denominator: the taxpayers’ investment.
If government put $1 million into Initiative A, did it generate enough taxes to cover that $1 million? In reality, a successful economic development initiative should have a ROTI greater than 1, otherwise why not use those tax dollars for health care?
A few examples:
A provincial economic development agency invests $1 million into a trade development initiative. Over the next three years, the companies involved generate $12 million in new sales, and using basic tax multipliers induced $2.7 million in provincial tax revenue. The ROTI was 2.7, meaning that for every dollar in, there were $2.70 worth of incremental tax dollars. The $1.70 surplus could be spent on health care and other public spending.
A local economic development agency invests $500,000 on a campaign that attracts 10 new export-focused entrepreneurs to the community. Those 10 firms create 45 jobs in the first three years and induce $510,000 in property tax revenue (business and household). That provides a ROTI of just 1.02. It’s barely breakeven but every incremental tax dollar from year 4 onward is gravy. So, the five-year ROTI is more than 1.5 and the 10-year ROTI is more than three.
As I anticipated, there are considerable challenges with this model.
Some people abuse it. I was asked to develop an economic impact model for a client who had one of the big consulting firms do the same model a few years earlier. The client figured I could do the work more cheaply (I’m kind of the Walmart of economic development services, pretty good quality at low cost). The group that did the previous work had calculated the client had an economic impact nearly three times the level my analysis implied. That firm was not clear with its methodology (proprietary), while I based mine on publicly available multipliers from Statistics Canada.
I am not suggesting the previous firm messed up the numbers but it looks like they threw everything but the kitchen sink into the model. I prefer my analysis to be clean and tidy. For example, the previous model had derived a taxes-generated-to-GDP ratio of something like 47 percent.
If you look at all government tax revenue relative to GDP for all industries, it is something like 23 percent. Therefore, when I do my models, if the client’s model shows them well above or well below the 23 percent, I go back in and try to figure out why. There would need to be something very significant to justify a number as high as 47.
The second challenge is data collection. Most economic development agencies don’t actually track their clients’ export revenue directly related to a specific initiative over a three-to-five-year period. Without the data, it is impossible to do the ROTI.
The third challenge is maybe the most challenging: did the economic development effort actually lead to the increased tax revenue? Many of the clients supported by government would have likely expanded anyway. They got the support of government because it was there. I once asked a large firm in New Brunswick if they needed the government funding and the response was “it was there, our competitors take it, why shouldn’t we?”
Good logic. Tricky for ROTI calculation.
In my opinion, this augers for more economic development support at industry or sector level, rather than firm level. If government makes an investment in a workforce development initiative for an industry – benefitting all firms – that might be a better way to go.
However, in fairness to my economic development colleagues, many times incentives are provided on competitive grounds (i.e. another jurisdiction is offering something similar). In this case, all I tell my clients is that the ROTI still needs to be positive or why bother.
If Jurisdiction A is offering a company $5 million in tax and cash incentives to set up and you offer them $5.1 million and that investment only generates $4 million in new tax revenue over a reasonable period, why make the investment? You are cutting $1.1 million out of money that could be provided to health care.
The last point I will make on ROTI relates to municipal government. As the lower level of government only gets about 8-9 percent of the tax revenue from any new economic development, it is important to focus on partnership between the levels of government. In general, we should look to avoid the free rider problem in economic development. The direct beneficiaries should also be ponying up the cash to support the economic development.
And, yes, this should mean, in many cases, the private sector. I know some have turned sour on private-sector funding for economic development, but I am still onside. I have seen real estate developers and sales professionals become millionaires because of government-led economic development. Lawyers, accountants, and many others benefit far more from economic development than the average person and therefore, for them to pony up a few bucks on the front end makes sense.
In general, Dr. Emery’s cost/benefit analysis should be part of any taxpayer investment and the logic should also apply to economic development.
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