The California Legislature has moved to prohibit local governments from offering certain sales tax incentives to promote economic development and attract businesses, such as e-commerce giant Amazon. Gov. Gavin Newsom has yet to decide whether to sign the bill, SB 531.

Critics have long argued that such tax incentives shuffle economic activity from one neighboring city to another, trap cities in a race to the bottom, and undercut the state and local tax base, often while failing to produce expected jobs.

They are not wrong. But prohibitions such as California’s, or penalties like those adopted in Arizona, may not be the best ways to end the misuse of economic development incentives. Policies that act as sticks often fail to keep pace with rapid economic change and the ability of local governments and businesses to design alternative incentive agreements that circumvent the curbs. Indeed, California has been trying to ban local governments’ use of harmful economic development tax incentives since the 1990s.

States may increase their odds of success by encouraging local governments to collaborate. Here’s how.

First: Encourage frequent communication, build trust

Cooperative programs must overcome local policymakers’ protective impulse and perception that economic development is a zero-sum game. Local economic development collaboration requires:

• Shared trust between local governments and within communities;
• Expectation of reciprocity among local policymakers;
• Frequent communication between local governments;
• Strong community partnerships with and between neighborhood and civic associations and nonprofit partners, for example, as well as with regional associations; and
• Clear information about how to form cooperative agreements.

My colleagues and I at the Urban Institute studied one community where local governments have put these principles into action: Montgomery County, Ohio.

In 2019, the region claimed the No. 2 spot, among metro areas of its size, for sheer number of economic development projects, according to one coveted industry-backed ranking. Researchers and policy groups, meanwhile, have often praised the region’s cooperative economic development efforts.

In 1992, the Dayton-area county established the Economic Development/Government Equity (ED/GE) program. This cooperative effort encourages frequent and transparent communication among participating cities, townships, and villages through its shared, 15-member governance structure. ED/GE staff say the initiative has fostered a more cooperative culture over time.

The county also operates Business First!, an information-sharing program that may help discourage local governments from poaching firms from one another. Several cities and townships in the region have, in addition, established state-authorized Joint Economic Development Districts (JEDDs). Representatives of ED/GE and the Miami Township-Dayton JEDD say these complementary programs contribute to a collaborative economic development culture in Montgomery County.

Second: Offer rewards for cooperation, not just penalties for competing

To win over cities, gains from collaboration must exceed potential costs, such as:

• Loss of autonomy;
• Revenue-sharing responsibilities; and
• Expense of implementing and monitoring an agreement.

Benefits can include access to:

• Grants or other financing incentives;
• Information about neighboring governments and local or national firm-siting discussions; and
• Economic development or business services too costly for a city to pursue on its own.

Montgomery County structures its ED/GE program around a suite of obligations and benefits. To become eligible for economic development grants, governments must contribute to the Government Equity fund when their property values grow. In turn, governments whose property values have lagged receive payments from the fund. This way, participants share the benefits of regional growth, reducing the temptation to poach businesses or quibble over project location.

In Colorado, the Metro Denver Economic Development Corporation requires its fifty governmental and nongovernmental partners to sign a code of ethics that bars them from poaching businesses. In return, participants have access to information about regional economic activity, strategic initiatives, and possible firm relocations. Partners are expected to notify one another if a business wants to relocate within the area. In turn, they are included in a list of potential locations when out-of-state firms approach Metro Denver.

Both Montgomery County and Metro Denver staff reported that nearly all local entities elect to participate in these collaborative arrangements because of the compelling benefits. Research, meanwhile, suggests that politicians can claim credit for the greater number of collaborative projects in the same way they do incentives. Powerful mayors, under political pressure to adopt new, bold initiatives, for example, are likely to pursue more collaborative economic development ventures because these can have larger overall impact.

Third: Make the (local) case for regionalism

In recent years, global competition for highly mobile, multinational firms has challenged local governments to formulate regional economic development strategies. According to one ED/GE representative, local governments agree to participate in cooperative economic development ventures when there is a “compelling case demonstrating that they won’t be as successful if they don’t work together.”

Even when motivated to work regionally, local governments may lack the necessary tools to promote collaboration. In that case, states can authorize or finance regional planning groups, like Councils of Governments. States may also adopt smart annexation and urban growth policies to prevent or reduce local fragmentation. While not necessarily a silver bullet against firm poaching, robust local participation in regional associations increases the likelihood of cooperation.

Without local cooperation, states will find themselves in a perpetual race-to-the-bottom, responding to the latest perceived abuse without really building capacity for regional economic development initiatives. Luckily, states have tools to create strong new incentives for local governments to work with, rather than against, each other for economic growth and opportunity.