do economic impact studies misrepresent the …...166 vol. 34, no. 3 do economic impact studies...

166 Vol. 34, No. 3

Do Economic Impact StudiesMisrepresent the Benefits of Arts

and Cultural Organizations?

ARTHUR H. STERNGOLD

As arts advocates, we need to stop making grandiose and unsubstantiatedclaims about the instrumental good that art can do and focus instead on whatart already means for individuals and society. —Joli Jensen (2003, 65)

ver 60,000 nonprofit arts and cultural organizations (NACOs) are regis-tered as federal tax-exempt entities in the United States (National Center

for Charitable Statistics n.d.), and there are thousands of smaller, unclassified,and unincorporated NACOs without this status (Toepler 2003). NACOsinclude arts and music festivals, science and history museums, performing artscenters, community theater leagues, and many other types of organizations.

NACOs enrich community life in countless ways, providing artistic andcultural experiences that entertain, educate, inspire, and provoke. They pro-vide outlets for creative expression and volunteer effort, strengthening socialcapital and civil society (Toepler 2001). By enhancing a place’s image andquality of life, NACOs may contribute to an area’s long-run economic devel-opment and appeal as a place to live, work, and invest (Florida 2002; Penne,Leo, and Shanahan 1987). Often, NACOs are formed through the grassrootsefforts of local residents to express unique aspects of local heritage and cul-

Arthur H. Sterngold is assistant professor of business administration and former direc-tor of the Institute for Management Studies at Lycoming College. He has worked as aneconomic planner for state government agencies in Florida and Georgia, where heprepared and evaluated economic impact studies and cost-benefit analyses.

O

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Do Impact Studies Misrepresent the Benefits of the Arts?

ture in ways that counteract the homogenizing influences of mass entertain-ment and media. These locally based NACOs help to define a commu-nity’s unique character and appeal.

Despite these contributions, NACOs face pressure to justify their govern-ment funding by proving that they produce measurable economic benefits. Asexplained in Arts and Economic Prosperity: The Economic Impact ofNonprofit Arts Organizations and Their Audiences (the AEP study), “as gov-ernments at all levels grapple with budgetary issues, the arts must competeagainst other pressing social, educational and economic development needs”(Americans for the Arts 2003, 17). In an article about the AEP study publishedin JAMLS, the study’s authors argue: “At this time in history, economic devel-opment is perhaps the most persuasive message when making the case for artssupport to local, state, and national leaders” (Cohen, Schaffer, and Davidson2003, 31).

Economic Impact Studies

To demonstrate that NACOs create tangible financial benefits, they oftenuse economic impact studies. The AEP study explains that, of all the ration-ales for funding NACOs, “[p]erhaps the most potent of these arguments—theone that resonates most with elected leaders, public and private sector funders,and policymakers—is the economic impact study” (17). A publication by theNational Assembly of State Arts Agencies (NASAA) states: “By using an eco-nomic impact study as one of the advocate’s arguments for supporting the arts,the arts are shown to be a critical element in the economic growth of a stateor community” (Barsdate 1997, 18). The NASAA booklet explains that usingimpact studies “can earn the arts ‘a place at the table’ with other state indus-tries” (9) and that the studies “have high credibility and are compelling to peo-ple on Capitol Hill” (21). The publication urges arts advocates to use eco-nomic impact studies to “portray public arts dollars as worthy investments,not subsidies or entitlements” (18).

Impact studies gained popularity in the 1970s by portraying NACOs as anindustry that provides jobs, tax revenues, and other economic benefits, and byviewing government funding of NACOs as a profitable investment of taxpay-ers’ dollars, rather than just a costly subsidy (Cwi 1987; Seaman 2000). Twoinfluential studies were the 1977 report, Economic Impacts of Arts andCultural Institutions: A Model for Assessment and a Case Study in Baltimore(Cwi and Lyall), which provided a prototype for future impact analyses, andthe 1983 study, The Arts as an Industry: Their Economic Importance to theNew York–New Jersey Metropolitan Region, which found that the region’s artsindustry supported $5.6 billion in regional output, of which 29 percent

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The Journal of Arts Management, Law, and Society

stemmed from the spending of visitors drawn to the area’s arts and culturalofferings (Port Authority of New York and New Jersey).

These early impact studies helped legitimize public support for NACOs, andthe number and influence of economic impact analyses grew rapidly in the fol-lowing decades. In 1987, Cwi observed that impact studies are “the most wide-ly funded form of arts research” (106). In a recent review, Christopher Madden(2001) found that NACO impact studies remain ubiquitous despite criticismsby many economists that the studies are overly simplistic, theoretically flawed,and of little practical value to policymakers (Krikelas 1992; Seaman 2000;Mills 1993; Hunter 1989). As Stefan Toepler explains, economic impact stud-ies are “still the tool of choice for arts advocates otherwise lacking convincingarguments to persuade skeptical local authorities to support the arts for any-thing other than the arts’ sake” (2001, 516).

The Arts and Economic Prosperity Study

Few impact studies have received as much media attention as the AEPstudy, which is the “most comprehensive economic impact study of the non-profit arts industry ever conducted” (American for the Arts 2003, 10). Thestudy found that NACO-related spending in the United States supports 4.85million full-time equivalent jobs, creating $134 billion in annual economicoutput, $89 billion in household income, and $24.4 billion in local, state, andfederal tax revenues. The study concludes: “By demonstrating that investingin the arts yields significant economic benefits, Arts & Economic Prosperitylays to rest a common misconception: that communities support the arts at theexpense of local economic development” (11).

Most dramatic, the AEP study claims that public financing of NACOs pro-duces an 8-to-1 return on taxpayers’ investment when the tax revenues gener-ated by NACOs are compared to the government aid given to NACOs. In anarticle published in the Newark Star-Ledger and posted on the Americans forthe Arts’ Web site, one of the AEP study’s authors writes that “[e]ven in boomtimes on Wall Street, no one imagines a return that big.” He concludes that“[g]overnment support for the arts is not a handout. It is a financially wiseinvestment in state and local economies throughout the nation” (Lynch 2003).

Conversely, the AEP study suggests that reducing government support ofNACOs produces undesirable effects: “When we hear talk about reducingsupport for the arts, we should ask: Who will make up for the lost economicactivity? . . . Who will replace the jobs that the arts support?” This point is dra-matically expressed by the headline of the Star-Ledger article: “New Jerseycan’t afford not to fund the arts” (Lynch 2003).

The AEP study’s assertions are striking because conventional impactanalyses focus rather narrowly on externally induced forms of short-term eco-

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nomic growth (Krikelas 1992). The studies are not designed to assess howNACOs enhance a community’s social amenities and quality of life nor howthese social benefits may contribute to an area’s long-term economic growthand vitality.

In their article in JAMLS, the AEP study’s authors explain that the study’sfindings were successfully used to help persuade Congress to increase theNEA’s appropriation by “the largest such increase in nearly twenty years. Theeconomic impact findings of the study were mentioned dozens of times dur-ing the debate as rationale for boosting the arts agency’s funding” (Cohen,Schaffer, and Davidson 2003, 30). During last spring’s Arts Advocacy Dayactivities in Washington, Americans for the Arts distributed a handbook toevery Congressional office that included this talking point based on the AEPstudy: “The NEA is a great investment in the economic growth of every com-munity in the country . . . Investment in the NEA provides economic growthand fights the federal deficit” (2004).

The “Free Lunch” Fallacy

Can these claims be true? Is government funding of NACOs truly a prof-itable investment of taxpayers’ dollars that promotes economic growth,reduces government budget deficits, and expands jobs, incomes, and tax rev-enues? Or do such claims reflect the logical fallacy: “There’s no such thing asa free lunch?”

In this article, I argue that economic impact analyses that use only grossmeasures of impact, such as the AEP study, fail to provide any evidence tosupport their claims because the studies overlook the substitution effects ofNACO-related spending. Just as estimates of a firm’s gross sales do not pro-vide any information about the firm’s net profits, so estimates of gross impactdo not provide any evidence that government funding of NACOs promoteseconomic growth, generates positive returns on taxpayers’ investment, or cre-ates more employment, income, and tax revenues than would exist withoutthat funding. As Seaman observes, finding that NACOs generate a large grossimpact “is a bit like proclaiming the existence of oxygen on the planet Earth.. . . Only the traditional unfamiliarity of many talented people in the arts withthe notion of themselves as economic agents could account for the perceivednovelty of this insight” (2000, 270).

On the other hand, impact analyses that properly use net measures of impactprovide more valid and useful information. However, these studies focus on“zero-sum” forms of economic growth in which the financial gains created bythe NACOs in some places are offset by corresponding losses in other loca-tions. For the United States as a whole, all of these gains and losses cancel,resulting in little net impact. At the national level, government support of

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NACOs is unlikely to spur economic growth or produce positive returns on tax-payers’ investment.

LOGIC OF ECONOMIC IMPACT ANALYSIS

Economic impact methodologies and the regional economic models onwhich they are based were originally developed to explain the effects ofexogenous changes in demand on an area’s economy, and in particular, toexplain the growth effects of increased spending for a region’s exports(Krikelas 1992; Hunter 1989; Schaffer 1999). When local firms sell moregoods or services to nonlocal buyers, it increases the amount of exportincome injected into the local economy. The effects of this expansion areamplified as portions of the new export dollars are retained and re-spentlocally.

For example, suppose a new nonprofit theater attracts a large number ofout-of-town visitors who spend money in the city to attend the theater’s pro-ductions and to dine at local restaurants. The theater and restaurants use someof this money to pay their employees and to buy supplies from local firms. Inturn, these workers and businesses spend portions of their earnings in thecommunity, and so on. Each additional round of spending amplifies the effectsof the visitors’ initial outlays, boosting the city’s overall levels of output,income, employment, and tax revenues. Impact analyses use various “multi-pliers” to reflect these secondary and aggregate effects (Krikelas 1992).

In recent decades, impact studies have increasingly relied upon input-output modeling systems that more accurately depict patterns of regional eco-nomic activity than do the simpler economic-base models used by earlierimpact analyses, replacing economy-wide multipliers with tables of sector-specific multipliers (Barsdate 1997, Krikelas 1992). However, as Schafferexplains, “the logic of input-output models is analogous to that of economic-base models” (1999, 22), and in particular, “[I]nput-output models are mostcommonly used to trace individual changes in final demand through the econ-omy over short periods of time. In this function, they are called impact mod-els, or multiplier models” (33).

Often, impact studies are used to examine the effects of a proposed gov-ernment project or policy, such as the closing of a military base or the open-ing of a government-funded arts center. Referring to these types of analysis,Mills explains: “The purpose of economic impact studies is similar to that ofenvironmental impact studies: to measure the positive and negative economicimpacts of a proposed project on people and businesses in the surroundingareas” (1993, 29).

In some cases, impact studies are used to gauge the economic impact orcontribution of an existing industry, organization, or activity, rather than the

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effects of a change in spending. To avoid confusion, I discuss these “level-of-spending” studies in a separate section.

Substitution Effects and Redistributions of Spending

To properly assess economic impact, the analysis must distinguish betweenexpenditures that represent true additions to regional demand (i.e., exogenousspending increases) and expenditures that represent diversions of dollars fromother regional uses.

Households, governments, and other spending sources face budget con-straints, and if they increase their NACO-related spending in a given period oftime, they are likely to reduce their expenditures for competing or alternativeuses or to acquire the money in ways that cause others to reduce their spend-ing. As the Baltimore study explains, “arts institutions vie for leisure-time dol-lars that might have been spent in the community even if they were not spenton the arts” (Cwi and Lyall 1977, 4).

These reductions in spending for substitute uses produce negative eco-nomic impacts that partly or fully offset the positive effect of an increase inNACO-related spending. Impact analyses must properly account for thesesubstitution effects to produce accurate results (Tyrrell and Johnston 2001).1

Consider again the nonprofit theater example, but assume that, in its firstyear, all of the theater’s patrons are local residents who reduce their spend-ing for other forms of local entertainment to attend theater productions. Thenegative impact of the reduced spending for these substitute uses reduces orcancels the positive effects of the residents’ theater-related spending.Similarly, if the city provides funding to the theater, it may have to reduceits support for other local programs or agencies, or it may increase localtaxes or the city’s indebtedness. Each of these alternatives produces nega-tive economic effects that offset the positive impact of the city’s theaterfunding.

Suppose the whole area of a pie represents the total amount of spending ina community, and each slice represents the portion of spending attributable toa particular industry or sector. Now, boosting the area’s NACO-related spend-ing will expand the slice of the pie corresponding to the community’s NACOs.However, if the increased spending is money diverted from other local uses,then the pie slices for the economic sectors linked to these substitute uses willshrink. Consequently, the overall size of the economic pie may stay the same.To create growth effects, the increase in NACO-related expenditures must cre-ate net additions to total spending so it expands the overall size of the eco-nomic pie, and not just the slice corresponding to the area’s NACOs.

Often, increases in spending and demand produce a mix of growth and sub-stitution effects. The user manual for RIMS II—an input-output modeling sys-

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tem developed by the federal government—explains this point. Describinghow to use the model to assess the impact of a new shopping mall, the man-ual states:

[I]t is necessary to estimate how much of the new project’s output replaces [sub-stitutes for] the existing output. For example, suppose a shopping mall is con-structed in a region that already has similar shops. If a portion of the sales at thenew mall would have occurred at the existing shops in the absence of the newmall, then the final-demand change due to the mall is only the net increase inregional sales. If in the extreme case, all the sales at the new mall would haveoccurred at the existing shops, the final-demand change due to the mall is zero.(U.S. Department of Commerce 1997, 26)

Estimating Net Additions to Spending

Impact studies must properly account for substitution effects to accuratelyestimate this “final-demand change.” As Seaman states: “It is important to rec-ognize that the impact calculations consist essentially of two component partsof a simple equation: Full impact = (multiplier) × (net additions to total spend-ing),” where the net spending increments represent “truly exogenous additionsto total spending,” rather than diversions of dollars from other local uses(2000, 271, 268). Accurately measuring these net spending additions is cru-cial because these estimates typically are the starting values entered into theinput-output models used to estimate economic impact. Tyrrell and Johnstonwarn that “[m]istakes made in estimation of the initial round of event-relatedexpenditures will carry through into subsequent applications of input-outputor multiplier analysis” (2001, 99).

To simplify the task of estimating net additions to local spending, impactstudies often restrict their analyses to expenditures by NACO patrons and vis-itors, ignoring other sources of NACO-related spending. They impose thisrestriction because expenditures by NACO audiences typically account for thelargest portion of all NACO-related spending. According to the AEP study, 40percent of the nation’s NACO-related spending consists of the organizationalexpenditures of NACOs, whereas 60 percent consists of related audiencespending. At the same time, audience payments to NACOs for admission feesand other items typically are the largest revenue sources for most NACOs.Consequently, most NACO-related spending stems from the outlays of NACOvisitors and patrons.

To further simplify their analyses, impact studies may assume (a) that anyincreases in NACO-related spending by local residents simply redistributedollars within the community “because most of the local spending would haveoccurred anyway” (Davidson and Schaffer 1980, 14). At the same time theincreases in NACO-related spending by nonlocal visitors as net additions toregional demand.2

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These nonlocal visitors face the same types of budget constraints as dolocal residents; if they increase their NACO-related spending in a particulararea, they are likely to reduce their spending for substitute uses in the placeswhere they live or otherwise would have spent their money. However, fromthe standpoint of the community that is the subject of the impact analysis, thenegative effects of these spending reductions are irrelevant because they occuroutside the area of interest.

The New Britain Impact Study

The Economic Impact of the New Britain Museum of American Art Expansion(Carstensen et al. 2000) is a recent study undertaken to evaluate the impact of aproposed expansion of a major art museum that would require $7 million in bondfinancing by the State of Connecticut. The study forecast that the expansionwould increase the museum’s attendance by forty thousand visitors annually.However, the study determined that 70 percent of these visitors would be stateresidents and out-of-state visitors whose museum attendance and related spend-ing would substitute for other activities and expenditures they would have madein Connecticut even without the museum expansion. Consequently, the studyexcluded these patrons from its analysis because their expenditures did not rep-resent net additions to the state’s economy. On the other hand, the New Britainstudy estimated that 30 percent of the new patrons would be “net new visitors”from other states whose trips to Connecticut were induced by the museum’sexpansion and whose museum-related spending would represent a net additionto the state’s economy. The study predicted these visitors’ expenditures wouldcreate fifty-four new jobs in Connecticut and boost the state’s economic outputby an average annual amount of $2.74 million and the personal income of thestate’s residents by $3.18 million annually.

Despite these positive impacts, the study concluded the expansion projectwould negatively affect the state’s tax revenues when all of the project’s costswere properly taken into account. For one, the state would have to make annual interest payments on the $7 million bond issue. In addition, the studyfound that the growth effects of the museum expansion would increase thedemand for state government services and the costs of providing those ser-vices. As a result, the study concluded the state would incur an average netloss of $470,000 per year in tax revenues until the bond was fully retired.

Diminishing Impacts at Higher Levels of Analysis

As explained earlier, when outside visitors increase their NACO-relatedexpenditures in a particular area, they are likely to reduce their spending in theplaces where they live or otherwise would have spent their money. These

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reductions in spending outside the area of interest produce negative effectsthat are comparable in magnitude to the positive impact of the visitors’increased NACO-related spending inside the area. As this suggests, the typeof externally induced growth that impact studies measure is a “zero-sum”game in which one place’s gains in NACO-related expenditures are offset bycorresponding losses in other places (Mills 1993).

The occurrence of substitution effects also implies that measures of eco-nomic impact depend greatly on how the area of analysis is defined, becausethis determines which substitution effects occur inside the area of interest andwhich occur in outside places.

For a small geographic area or political jurisdiction, such as a single county,much of the increase in the area’s NACO-related spending may stem from non-local visitors because the area is defined narrowly. However, as the area of inter-est becomes larger and more encompassing, such as a multicounty region orstate, more of these outside places fall within the area of interest, and so more ofthe substitution effects that previously occurred outside the area now occur in it.Due to this “level of analysis effect,” as the area expands, a growing proportionof the increase in NACO-related spending represents a redistribution of localexpenditures rather than a net addition to the area’s spending.

When discussing the impact of the new shopping mall on local businesssales and sales tax revenues, the RIMS II user manual explains the level-of-analysis effect in this way:

[S]uppose a new shopping mall in a county draws a large share of its shoppersfrom nearby counties, where they previously shopped. For the county with themall, the impact on sales and sales tax revenues is substantial. However, for themulticounty region, the impact of the mall also reflects the offsetting declines[substitution effects] in sales and sales tax revenues in the nearby counties, sothe impact on sales and sales tax revenues is smaller than that for the county.(U.S. Department of Commerce 1997, 7)

Similarly, an analysis of two arts festivals held in Charleston, SouthCarolina, found that the events create a larger impact in the Charleston areathan in the state as a whole due to level-of-analysis effects. The studyexplained that many of the nonlocal visitors drawn to the Charleston area bythe festivals live in other parts of the state, and so the spending by these visi-tors “injects new money into the Charleston economy, but not into the stateeconomy as a whole” (Moore School of Business 2002, 13).

Now, for the United States as a whole, practically all NACO-related spendingstems from the expenditures of U.S. residents and other domestic sources, suchas government agencies and private foundations.3 At the national level of analy-sis, all of these sources are “local,” and so for the reasons given earlier, incre-ases in their NACO-related spending only divert dollars from other domesticuses, rather than creating net additions to the country’s overall level of spending.

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This implies that for the nation as a whole, increasing government subsidiesto NACOs does not produce growth effects, contrary to the claims of the AEPstudy. The additional funding may produce large distributional effects that stim-ulate the growth of some industries and regions, but these gains will be offset bythe negative impacts on other sectors and parts of the country. Conversely,reducing government subsidies to NACOs is unlikely to negatively affect thenation’s overall levels of economic activity, employment, and income.

Problems with Gross Change-in-Spending Impact Studies

As I explain in this article, impact analyses must account for substitutioneffects to properly assess the impact of NACO-related spending. Goodmanand Feser write that “the economics of displacement [substitution] are ele-mentary and uncontroversial,” and “any impact analysis expected to informpolicy must account for displacement effects” (2003, 6). Tyrrell and Johnstonexplain that unless the impact analysis properly accounts for substitutioneffects, “the resulting impact estimates may at least partially confuse the truenet economic impact of the event (the actual net increase in regional expendi-tures directly related to the event) with gross economic impact (the totalexpenditures of all event visitors and participants)” (2001, 99).

Despite this, some impact studies ignore substitution effects and only usemeasures of gross impact. When an area’s NACO-related spending expandsdue to increased government support or for other reasons, it increases thegross amount of economic activity directly and indirectly linked to that spend-ing. Part of this gross increase may reflect a net gain in the area’s overall levelof economic activity, and part may reflect a transfer of spending from substi-tute uses within the region. By ignoring this distinction, gross impact studiesdo not shed any light on whether an increase in NACO-related spending pro-duces growth effects or not.

Consider that expanding an area’s NACO-related spending may producea positive gross impact but a negative net effect (Tyrrell and Johnston 2001).For example, suppose a community decides to host a musical festival andthat most of the festival’s revenues are used to pay out-of-town performersand vendors who spend all of their earnings in the places where they live.Also, assume that most of the festival’s attendees are either local residentsor nonlocal visitors whose festival-related spending substitutes for dollarsthey would have spent at more permanent local establishments (e.g., restau-rants, movie theaters) if the festival did not occur. Although the festivalincreases the gross amount of NACO-related spending in the community, itmay negatively affect the area’s overall level of economic activity if the fes-tival causes more money to leak out of the area than would have in the fes-tival’s absence.

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Even when increases in NACO-related spending do create positive neteffects, gross impact studies exaggerate the impacts. If the New Britain studyhad ignored substitution effects and provided gross rather than net measuresof impact, it would have overstated the effects because the study predicted thatonly 30 percent of the increased museum attendance represented “net new vis-itors” to the state whose expenditures would inject new dollars intoConnecticut’s economy.

In their review of several economic impact analyses of major tourismevents held in Rhode Island, Tyrrell and Johnston (2001) found that the stud-ies which ignored substitution effects and used gross measures of impact over-stated the events’ net impacts by amounts ranging from 50 to 500 percent.Similarly, Crompton, Lee, and Shuster (2001) describe a study undertaken fora large city that overestimated the impact of a city-sponsored event by overtwenty-fold due to its use of gross rather than net measures of impact andrelated errors. Even The Port Authority study found that the net impact of vis-itor spending accounted for only 29 percent of the gross impact of all artsspending in the New York–New Jersey metro area, despite the fact that thestudy assumed the arts constitute a larger export industry in New York than inany other metropolitan area (Port Authority 1983, 139).

The Mountain Laurel Study

The errors produced by gross impact studies can have serious policy con-sequences. Consider the new Mountain Laurel Performing Arts Center inBushkill Falls, Pennsylvania, which received more than $36 million in stateand federal funds. The center was developed as a fine arts venue for classicaland contemporary music, dance, and Broadway-style theater, and to serve asthe summer home of the Pittsburgh Symphony Orchestra. The center had adisastrous opening season in 2003, closing after seven months due to a mount-ing financial debt. Although the center’s board and government officials areworking feverishly to save the project, its financial prospects are dim(Charlanza 2004). Many observers questioned the arts center’s financial via-bility from the beginning, skeptical the center could draw sufficient numbersof “fine arts” patrons to its rather remote location in the Pocono Mountainsregion of Pennsylvania.

To help secure government funding, the regional development authority thatowns the arts center commissioned an impact analysis to assess the project’seconomic benefits. The final and most conservative version of this study pre-dicted that in the five-county region surrounding the center, the center’s oper-ations and related audience spending would create 1,273 permanent new jobsand produce annual increases of $34.8 million in household income, $82.4 mil-lion in economic output, and $668,000 in property taxes (Zaricki 1993). For the

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state as a whole, the study predicted the project would create even larger eco-nomic benefits, including $3.3 million annually in state tax revenues. Theimpact study received much media attention and was successfully used to helpgain state and federal funding for the arts center.

However, unlike the New Britain study, which properly restricted its analy-sis to the net increase in visitor spending induced by the museum’s expansion,the Mountain Laurel study used a gross impact analysis that did not distin-guish between net additions to regional spending and diversions of spendingfrom substitute uses within the region.4 Despite this, the impact study repeat-edly referred to its estimates of the gross volume of jobs, tax revenues, andother economic benefits the arts center would support as “new,” “additional,”and “increased.” Perhaps the study’s exaggerated claims about the project’simpact encouraged lawmakers and citizens to uncritically support a projectwhose long-term viability was doubtful from the start.

Furthermore, by using gross rather than net measures of spending, theMountain Laurel study overlooked level-of-analysis effects. The study esti-mated that the arts center would generate $1.9 million in additional householdincome per year in the five-county region where the center is located, com-pared to $3.1 million annually for the state as a whole. However, a large por-tion of the people expected to attend the arts center’s concerts live in otherparts of Pennsylvania, including the Philadelphia and Scranton–Wilkes-Barremetropolitan areas. Consequently, estimates of the arts center’s impact for theentire state should have excluded the expenditures of these residents fromother parts of Pennsylvania.

LEVEL-OF-SPENDING IMPACT STUDIES

The New Britain and Mountain Laurel studies are examples of “change-in-spending analyses” that assess the impact of proposed or likely changes in anarea’s NACO-related spending. In some cases, impact studies assess the eco-nomic contribution of an existing industry, organization, or event. Rather thangauge the impact of a change in spending, these studies examine the econom-ic activity supported by a source’s current level of spending. For example, theAEP study uses “level-of-spending” analysis to estimate the economic contri-bution of the nation’s NACOs.

For explanatory purposes, the economic contribution in a level-of-spending study can be viewed as the impact of removing the industry, organi-zation, or event that is the source of that contribution, and the impact of elim-inating all the spending and economic activity that is uniquely attributable tothe source. For example, The Economic Impact of the Cultural Industry on theState of South Carolina (Moore School of Business 2002) includes a level-of-spending analysis of the state’s two largest outdoor arts events, the Spoleto

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USA and Piccolo Spoleto festivals. The study found that out-of-state visitorsspend $26.3 million annually at these festivals, producing a net contribution tothe state’s economy of $16.7 million in salaries and wages, $40.6 million ineconomic output, and 908 full-time equivalent jobs. This level-of-spendingstudy can be viewed as a change-in-spending analysis of the effects of elimi-nating the Spoleto USA and Piccolo Spoleto festivals. If the festivals were can-celled, much of the spending linked to the festivals would be transferred to sub-stitute uses in South Carolina. However, the portion of the festival-relatedspending that represented an exogenous addition from out-of-state visitorswould be lost. The economic impact of this lost income is the net contributionof the two festivals. As the South Carolina study explains, “The money spentat these festivals by nonresidents is a true net addition to the [state’s economy].If the Spoleto USA and Piccolo Spoleto festivals were to cease, the impactscreated by the festivals would actually disappear from the economy” (7).

PROBLEMS WITH GROSS LEVEL-OF-SPENDING STUDIES

As is the case with gross change-in-spending analyses, some level-of-spending studies use gross estimates of economic impact without attemptingto isolate the portion of that contribution that represents an exogenous addi-tion to regional economic activity. These gross contribution studies may pro-vide useful information about the economic scale of a particular industry,organization or event, or about the source’s interconnections with other eco-nomic sectors and activities. However, gross level-of-spending analysesshould not be confused with studies that measure net impact or contribution.As explained by the Department of Parks, Recreation and Tourism Resourcesat Michigan State University:

To distinguish between spending of local and non-local residents, two distinctimpact analyses may be carried out, what we call “impact” and “significance”analyses. An impact analysis only includes spending by visitors who resideoutside of the local region. Their spending constitutes “new dollars” to theregion. A significance analysis includes the effects of spending by all visitors,both those who reside in the local area and those who do not. The significanceanalysis should generally not be interpreted as an estimate of the loss to thelocal region if the project/program were closed, since much of the spendingby local residents would likely stay within the region, but perhaps be shiftedto other sectors.

Similarly, the South Carolina study refers to gross level-of-spending analy-ses as “economic-linkage studies.” The study includes a gross level-of-spend-ing analysis that finds that South Carolina’s cultural industry supports 30,018jobs in the state. However, the study is careful to explain that this method ofestimating gross contribution

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. . . is an acceptable approach to impact analysis as long as the effects are inter-preted correctly. For example, the 30,018 jobs . . . are jobs that are supported byactivities of the cultural industry. That is, these are existing jobs in the state thatare related to the cultural industry through various inter-industry linkages.However, these are not necessarily new jobs that were created by the arts inSouth Carolina. (Moore School of Business 2002, 6)

Gross Level-of-Spending Studies Do Not Provide Evidence of Growth Effects

The AEP study and its related publications suggest that because NACOsgenerate a large gross impact, it follows that government funding of NACOs(and NACO-related spending in general) stimulate economic growth, creatingjobs, incomes, and tax revenues. However, the AEP study does not provide anyevidence to support these claims because it uses only gross measures of impact,without attempting to distinguish between the growth and redistributional com-ponents of that impact. As Seaman explains, “simply documenting the relativesize of arts spending versus nonarts spending is a useful exercise in data gath-ering. But these effects should be distinguished carefully from claims relatedto the overall growth and health of the local economy” (2000, 276).

In fact, the public financing of NACOs is unlikely to create growth effectsin most places. In the United States, commercial enterprises control the largestand most profitable aspects of arts and cultural production. In comparison,most NACOs are small operations that primarily serve local markets and gen-erate little export income. According to Penne, Leo, and Shanahan (1987,144), “arts as industries, in all but a few places, will not be among the strongerproducers of net new jobs or income for the regional economy.” Seamanexplains: “Arts impact studies have established little evidence that the arts area basic industry, defined as an export industry, an important substitute indus-try, or an industry providing services critical to an export industry” (2000,277). Of course, there are many exceptions to this rule, such as the NACOs incities and regions that are major centers of arts and culture (e.g., New Yorkand Los Angeles) and NACOs that are tourist destinations in their own right(e.g., Rock and Roll Hall of Fame, Newport Jazz Festival). However, theserepresent a small portion of the nation’s NACOs.

The AEP study and its ancillary documents also suggest that reducing gov-ernment funding of NACOs will produce undesirable economic effects.However, just as gross contribution studies provide no evidence of growtheffects, they also do not show that reduced government support for NACOshas adverse economic consequences.

As explained earlier, a level-of-spending study can be viewed as a specialtype of a change-in-spending analysis that assesses the impact of eliminatingan industry, organization, or event. However, it is extremely misleading tointerpret gross contribution studies in this manner because they fail to take

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into account the substitution effects that dampen the negative impact ofremoving a spending source.

Substitution effects reflect the natural trade-offs that households, govern-ments, and other entities face when adapting to changes under budget con-straints. These substitution effects reduce the negative effects of undesirableshocks in the same way that they dampen the positive impacts of favorablechanges. According to Seaman,

When someone reports that the Chicago Symphony Orchestra has added, say,$150 million to the Chicago economy in a particular year, one should realizethat the disappearance of the institution, tragic as that would be for other rea-sons, would be unlikely to reduce total personal income in Chicago by $150million. It certainly would affect individual suppliers of inputs to the orchestraand all of the subsidiary results that an input/output table could trace. But unlessaggregate spending in the area were reduced rather than simply transferred, theeffects again would be largely distributional. (2000, 277–78)

If the Chicago Symphony Orchestra closed, many of its patrons wouldincrease their spending for other cultural offerings or leisure activities in theregion, orchestra employees would seek jobs with other area employers, sup-pliers would find new customers, and so on. The positive effects of theseincreased expenditures for substitute uses would partly or fully offset the neg-ative impact of the orchestra’s closing on the Chicago area’s economy. As theBaltimore study explained: “[I]t cannot be inferred that the economic effectswould not have occurred had the examined institutions not existed” (Cwi andLyall 1977, 3–4).

To use a traffic analogy, suppose a study finds that 20 percent of local dri-vers use the intersection at Main and Market Streets on a typical day. If theintersection were closed, most drivers would find alternative routes and inter-sections to get to their destinations, resulting in little or no net reduction in thecity’s overall traffic volume. Similarly, if an area’s NACOs were eliminated,most or all of the region’s NACO-related spending would be directed to sub-stitute uses, mitigating the adverse consequences.

Gross Level-of-Spending Studies Do Not Indicate Significance

Some argue that despite their limitations, gross contribution studies pro-vide useful information about the economic size and importance of industries,organizations, or events. For example, the AEP study claims it “provides com-pelling new evidence that the nonprofit arts are a significant industry in theUnited States” (Americans for the Arts 2003, 1).

An industry’s gross contribution is largely a function of its size; thus, thisrationale for gross impact studies makes sense if one equates size and impor-tance. However, there is little evidence that industry size is an indicator of an

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industry’s significance to an area’s economic development or well-being(Seaman 2000; Madden 2001). According to the AEP study, “Any time moneychanges hands, there is a measurable economic impact” (20). As this state-ment suggests, all organizations and activities that spend money produce pos-itive gross impacts, including tanning salons and pizza parlors. That someentities produce larger gross impacts than others says little about their eco-nomic significance. For example, a small industry that is growing rapidly andprovides good job training and advancement opportunities may be much moreimportant to an area’s economy than a larger industry that has stagnant salesand mostly provides dead-end jobs, even if the larger industry produces a big-ger gross impact.

Furthermore, measures of gross contribution can be rather easily manipu-lated by varying how broadly or narrowly the industry is defined. For this rea-son, the representatives of different industries, such as tourism and agricul-ture, can simultaneously cite studies showing their industries are the largest ina particular region or state (Schaffer 1999). The AEP study defines NACOsbroadly to include public radio/television stations and fund-raising organiza-tions, whereas the South Carolina study goes even further by including a por-tion of the budgets of the state’s public libraries and schools in its estimate ofcultural spending. Cwi observes that “[w]hen the objective is a statement ofthe largest possible arts impact, studies cast their net widely” (1987, 116).

Gross Impact Studies Do Not Show that Public Financing of NACOsProduces Positive Returns on Taxpayers’ Investment

Perhaps the most misleading claim made by gross impact studies is thatpublic financing of NACOs is a profitable investment of taxpayers’ dollarsthat produces healthy returns in the form of increased tax revenues. For exam-ple, the AEP study found that NACOs directly and indirectly generate $24.4billion in local, state, and federal taxes per year (of which $10.5 billion is fed-eral), whereas NACOs receive less than $3 billion in direct public support (ofwhich $1.4 billion is federal).5 The study concluded that government supportof NACOs produces an 8-to-1 return on taxpayers’ investment, based on theratio of the tax revenues supported by NACOs to the subsidies received byNACOs, using either the total or federal data.

Now, in those places where government funding of NACOs does not pro-duce growth effects, which include most communities and the United Statesas a whole, the funding is unlikely to create net increases in tax revenues orpositive returns on taxpayers’ investments. In these places, the loss in tax rev-enues from the reduced spending for substitute uses offsets the gains in taxrevenues from increased NACO-related spending, resulting in little net effect.Although public support of NACOs may positively affect tax collections in

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some places and situations, there is no reason to believe this effect occurs forthe nation as a whole or for the average region. Only by ignoring substitutioneffects and using gross measures of impact can the AEP study and similargross impact analyses conclude otherwise.

Even in places where public funding of NACOs does produce growtheffects, the methods employed by the AEP study to estimate the 8-to-1 returnon the taxpayers’ investment overstate the true returns. To estimate the return,the study includes the gross amount of tax revenues that is directly and indi-rectly supported by all NACO-related spending. However, to compute the cor-responding government costs, the study only counts the direct public subsi-dies to NACOs, ignoring public sector costs that are indirectly attributable tothe nation’s NACO-related spending. As the New Britain study indicates, inplaces where public support of NACOs spurs economic growth, those growtheffects are likely to increase the demand for government services and the costsof providing those services. These costs must be included in estimating therate of return on the taxpayers’ investment in NACOs.

At the same time, the AEP study counts the entire gross amount of tax rev-enues directly and indirectly generated by the nation’s NACOs in its measureof the returns, rather than just the portion of these revenues attributable to thepublic investment in NACOs. In the absence of any direct government subsi-dies, most NACOs would continue to operate, generating a substantial ifsmaller volume of NACO-related spending than currently exists. The tax rev-enues supported by this unsubsidized amount of NACO-related spendingshould not be included in estimating the rate of return on the public’s invest-ment in NACOs.

DO IMPACT STUDIES JUSTIFY PUBLIC SUPPORT OF NACOS

AS TOOLS OF ECONOMIC DEVELOPMENT?

The ubiquitous use of impact studies reflects a larger tendency to treatNACOs as tools of tourism promotion and economic development policiesand to justify public financing of NACOs on this basis. By exaggerating thegrowth effects of NACOs, gross impact studies encourage this view ofNACOs.

As explained earlier, government funding of NACOs does not producegrowth effects for the U.S. economy as a whole. Practically all NACO-related expenditures in the United States stem from domestic or “local”sources; therefore, increasing these outlays only diverts dollars from otherdomestic uses rather than creating net additions to the nation’s economic out-put. Although public financing of NACOs may generate growth effects insome regions and states, these gains are offset by corresponding losses inother parts of the country.

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Even in places where public support of NACOs may stimulate the type ofeconomic growth that impact studies measure, it is unlikely to produce largergrowth effects than those created by government programs specificallydesigned for that purpose, such as public investments in airports, highways orworker training programs. In many places, government funding of NACOsmay even be less effective in promoting growth than would leaving the moneyin the hands of the residents whose incomes were taxed to pay for the subsi-dies, which would increase the residents’ local spending and consumption. Asthe 1977 Baltimore study explained, impact studies cannot infer that “supportfor the arts, as an economic development strategy, is to be preferred over otheralternative uses of public or private dollars” (Cwi and Lyall, 3).

Are Gross Impact Studies a Misapplication of Economic Theory?

No empirical investigation can account for all of the effects of an economicaction or change, and for this reason, economic studies use the methods ofcomparative statics and partial equilibrium analysis to simplify their investi-gations. In particular, the studies may ignore secondary effects the researchersbelieve are small compared to the effects that are the focus of analysis, effectsthat are difficult to measure, and effects that are unimportant to policy deci-sions (U.S. Environmental Protection Agency 1983, M10).

However, ignoring substitution effects by using gross measures of impactdoes not satisfy any of these criteria. As Goodman and Feser explain, “theeconomics of displacement [substitution] are elementary and uncontrover-sial,” and “any impact analysis expected to inform policy must account fordisplacement effects” (2003, 6).

As I have argued, reductions in spending for substitute uses can producesizable effects that largely or completely offset the benefits of increases inNACO-related spending, and consequently, gross measures of impact thatignore these substitution effects may greatly overstate the actual net values.Moreover, as the area of interest becomes larger and more encompassing,these inaccuracies tend to become more pronounced.

Furthermore, as the New Britain and South Carolina studies show, esti-mating substitution effects is not a terribly difficult task from either a method-ological or practical standpoint. Many impact studies attempt to properlyaccount for substitution effects, and several articles describe the methodol-ogies for doing so (see, for example, Crompton, Lee, and Shuster 2001;Tyrrell and Johnston 2001; U.S. Department of Commerce 1997).

As the Mountain Laurel example illustrates, ignoring substitution effectscan have significant policy implications. Moreover, it virtually guarantees thatgross impact studies will find that any government-financed project creates afavorable impact, regardless of the project’s actual costs and benefits.

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According to Hunter, “[t]he use of the multiplier principle to compute the total[gross] impact of a public works project on the local economy guarantees thatestimates of community benefits will always exceed estimates of communitycosts” (1989, 12). Similarly, in his review of dozens of impact studies of largegovernment-funded projects, Mills (1993) found that all the analyses system-atically ignored substitution effects, and for this reason, the studies necessar-ily concluded that the projects created positive economic impacts.

For these reasons, many economists view gross impact studies as a misap-plication of economic theory (Mills 1993; Hunter 1989). Referring to grossimpact studies as “size analyses,” Madden explains: “Technically, size analy-ses are not economic impact methodologies at all, as is evident in their omis-sion from summaries of impact methodologies in the economics literature.. . . Economic impact studies proper measure net financial flows, not gross

financial quanta” (2001, 163).

CONCLUSION

Impact analyses that use gross measures of impact fail to provide any evi-dence that public funding of NACOs promotes economic growth, producespositive returns on taxpayers’ investments, or increases an area’s overall lev-els of employment, income, or tax revenues. Conversely, gross impact studiesdo not provide evidence that reducing government support of NACOs pro-duces an opposite set of undesirable effects. Gross impact analyses providefew insights into the economic significance of NACOs or into the justifica-tions for taxpayers’ funding of NACOs.

By overstating the economic benefits of NACOs, gross impact studies mis-lead NACO managers, lawmakers, and the public, and as the Mountain Laurelexample suggests, the studies may lead to poor policy decisions that squanderscarce public resources. Although many government decision-makers maydiscount the results of biased impact studies, the analyses can significantlyaffect policy decisions, even if only a small portion of public officials and cit-izens are influenced.

Justifying public support for NACOs in terms of their economic impactencourages NACO managers, lawmakers, and the public to treat NACOs astools of tourism promotion and economic development policies. This favorsthe funding of more tourist-oriented NACOs that can attract large amounts ofvisitor spending, and it puts at a disadvantage smaller and more locally ori-ented NACOs that may contribute more to a community’s quality of life andlong-term development than do their larger counterparts.

Overemphasizing and overstating short-term financial benefits can alsoundermine the public legitimacy of NACOs (Toepler 2001), and it encouragescommunities to set up NACOs that are more the creations of economic devel-

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opment agencies and chambers of commerce than of local residents. This mayhelp to explain the proliferation of new and proposed cultural “halls of fame”whose chief purpose is to attract tourist dollars, including a National ComedyHall of Fame in Buffalo, New York, separate Cowgirl and Cowboy Halls ofFame in Fort Worth, Texas, a Ukulele Hall of Fame in New England, and asecond Rock and Roll Hall of Fame in Arnolds Park, Iowa (Passey 2003). Asthe Baltimore study warned nearly thirty years ago, “strategies pursued solelyto increase the long-run economic impact of particular arts programs mightlead directly to a decrease in the quality of arts activities” (Cwi and Lyall1977, 29).

Public financing of NACOs may be justified by the ways in which NACOsenrich the quality-of-life of community residents, express unique aspects oflocal heritage and culture, and contribute to an area’s social capital and long-term development. However, these benefits are beyond the scope of conven-tional impact analyses, which focus on more short-term and externallyinduced forms of economic growth. By exaggerating these effects, grossimpact studies divert attention from NACO benefits that are more genuine andenduring. As Seaman argues, by relying on impact studies to justify publicsupport of NACOs, arts advocates “are choosing to play one of their weakestcards, while holding back the aces” (2000, 280).

NOTES

I wish to thank Arthur Brooks and Stefen Toepler for their guidance and encouragement, ananonymous reviewer for his or her helpful comments, and Eva Breneisen and the HeldrefPublications staff for their editing talents.

1. The degree to which the negative effects of reductions in spending for substitute uses offsetthe positive impact of increased NACO-related spending depends on the specific amounts andtypes of substitute spending, the regional multipliers for the affected industries, and other factors.

2. To more accurately estimate the effects of NACO-related expenditures, impact analysesmay take into account increases in spending by local residents that represent true additions tolocal expenditures, increases in spending by nonlocal visitors that substitutes for local expendi-tures these visitors would have made anyway, and increases in NACO-related spending by othersources, such as government agencies or private foundations (Crompton, Lee, and Shuster 2001).Including these factors does not affect the basic logic of the impact assessment, and so I do notdiscuss them in this article.

3. Consider the Spoleto USA festival, which is South Carolina’s largest and best-known annu-al arts event and which attracts an unusually large number of international tourists. The festival ismodeled after the Festival dei Due Mondi in Spoleto, Italy, and it has a strong international focus(Moore School of Business 2002). Despite this, audience surveys show that international visitorsaccount for less than 3 percent of the festival’s attendees, and it is likely that only a small portionof these patrons traveled to the U.S. (or extended their stays) specifically to attend the festival. Onaverage, these international tourists spend the same amount of money as do U.S. residents fromother states on such items as admission to festival events, overnight lodging, and other festival-related items. In comparison to the Spoleto USA festival, international tourists undoubtedly rep-resent an even smaller share of audience members for the average NACO. For example, interna-tional tourists account for less than 2 percent of the attendees at the annual Piccolo Spoleto fes-tival, which is South Carolina’s second largest arts event and which is a smaller version of theSpoleto USA festival.

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4. The author of the Mountain Laurel study explained to me that he was only given aggregateestimates of audience size and spending, and so he was unable to distinguish between the localand nonlocal components of that spending in his economic analysis.

5. These estimates of direct government subsidies do not include the billions of dollars thatNACOs receive in indirect aid in the form of the tax revenues foregone on tax-deductible dona-tions to NACOs by individual contributors, which produce $14 of indirect aid for every dollar indirect federal assistance (Brooks 2004).

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