Incentives aren't the free ride they used to be.

For decades, states and local governments have doled out grants and tax breaks to companies that say they will move in and create jobs. But officials are getting tired of businesses that renege on their promises or simply pick up stakes after collecting their cash.

Now governments are making sure that their incentive plans come with a catch. Many are using "clawback" provisions that let governments recover their money if companies leave town or go belly-up. In other cases, governments don't pay companies until they actually create jobs. One city is even proposing a "no poaching" agreement to get more leverage over businesses, where neighboring cities promise to limit the use of incentives to lure companies from each other.

Consider the case of Instinet Inc. When the institutional brokerage firm, then known as Instinet Group, moved some back-office operations to New Jersey from New York City in 2002, it projected it would create 300 jobs and estimated it would spend $14 million on things like new computers and offices.

By 2004, the company was well on its way: It had created 233 jobs and leased 144,000 square feet of office space. In return, the state of New Jersey and Jersey City gave the company more than half a million dollars in cash grants.

Two years later, though, Instinet quit New Jersey. The Nasdaq Stock Market acquired part of the firm, and the jobs left New Jersey.

But it was no bother to New Jersey: Thanks to clawback provisions, in November Nasdaq repaid New Jersey the entire $542,856 Instinet had received.

"The bottom line is very clear: If a company picks up and leaves New Jersey, they have to fully repay," says Caren Franzini, chief executive of the New Jersey Economic Development Authority. Insinet, now a unit of Nomura Holdings Inc., declined to comment.

Getting Tough

The reasoning behind tightening up incentives is sound enough. But much like shareholders trying to rein in executive pay, states have had a tough time breaking their cycle of easy incentives.

Part of this is groupthink: With so many communities offering economic incentives, it's hard for neighbors to resist offering the same thing as the other guy. Also, companies have gotten more sophisticated in seeking incentive deals, often by hiring consultants that play one community against another to extract more money. And states that do have clawbacks are often reluctant to enforce them because it can make them appear antibusiness.

But things are changing as incentive offerings get bigger and more varied. North Carolina, Texas and Florida, for instance, have multimillion-dollar funds that can be used to lure companies that are being heavily wooed by other states.

With all that money on the line, states are looking for better ways to protect themselves.

"There is so much at stake, these deals are so much in the public eye, that the elected officials have to ensure that those tax dollars are well spent," says Karin Richmond, principal at consulting firm Intelligent Incentives in Austin, Texas.

A look at Duluth, Minn., illustrates how -- and why -- states have firmed up their incentive programs. Located in northern Minnesota, the city of 90,000 was going through rough economic times in the early 1980s. So in 1981, when local firm Diamond Tool & Horseshoe Co. was up for sale, it was in Duluth's economic interest to help the company any way it could.

Using industrial revenue bonds, Duluth extended a $10 million loan to help Triangle Corp., of Stamford, Conn., buy the company and keep it in town. A few years after completing the purchase, Triangle had laid off around 400 of the company's 750 employees -- and later announced plans to move manufacturing equipment to a lower-cost plant in South Carolina.

Today, Minnesota has a law that requires clawback provisions in most economic development grants. The law also requires that most business subsidies over $25,000 be reported to the public by the Minnesota Department of Employment and Economic Development.

The law has had an effect: It has taken a few years for the clawbacks to start, but over the past two years communities in Minnesota have reclaimed more than $4 million in economic incentives.

Some states have had clawbacks on the books for years but are getting more aggressive about enforcing them. Virginia's Governor's Opportunity Fund has had clawback provisions since the late 1990s, but until recently the state didn't systematically check in on companies to see if they'd created as many jobs as projected.

In 2002, the state stepped up its auditing of companies and billing those that hadn't followed through. The state has collected about $11 million in repayments since the program was started, about 90% of it in the past five years.

"We really got aggressive, methodical and more self-protective," says John Sternlicht, general counsel and legislative director of the Virginia Economic Development Partnership.

At least 20 states now have some kind of clawback written into their economic-development programs, compared with just a handful in 1994, according to Good Jobs First, a nonprofit research center that studies economic development. In 2004, New Jersey's Business Employment Incentive Program, which gives grants for creating new jobs, was beefed up with the new provisions that allowed it to reclaim money from companies like Instinet.

Cash on Delivery

Instead of giving money up front, many states have structured their incentive programs so that companies only get money after they've created jobs. One way of doing this is to parcel out a grant or tax break over a period of years, along the way checking to make sure companies are meeting employment goals.

Another method is to structure incentives so that company employees essentially pay their income tax to the company instead of to the state. That's the idea behind Missouri's Quality Jobs program, which started in 2005 and gives benefits to companies that relocate or expand in the state.

Here's how it works: To qualify for the program, companies that relocate or expand in Missouri have to create jobs that are above the average wage in the county where the jobs are created. Companies that create those jobs get to keep the payroll taxes each new employee generates for five years, instead of sending the money along to the state.

"If you never create the jobs, then you never retain anything," says Mike Downing, division director of business and community services with the Missouri Department of Economic Development.

Some cities have tried getting together to fight back against companies. In northeast Ohio, businesses have jumped between Cleveland's suburbs, sometimes grabbing new incentives.

Last year, the city of Middleburg Heights accused neighboring Strongsville of offering more than $1 million in property-tax breaks to lure offices of a United Parcel Service Inc. subsidiary, and its 300 or so jobs, to its city. ("The deal was brought to our attention by a broker," says Eugene Magocky, economic-development director for the City of Strongsville. "We did not try to steal UPS.")

The recent spat, and other incentive deals, have inspired a group of communities to look for ways to cut back on incentives. Early this year, the Cuyahoga County Mayors and City Managers Association proposed a deal where the cities surrounding Cleveland would share income-tax revenue and limit the use of property-tax abatements that lure businesses from one community to another.

"It's a 'united we stand' kind of approach," says Charles Bichara, director of economic development for Middleburg Heights.

A Long History

States have used economic incentives to lure businesses for at least 150 years, according to James Cobb, a history professor at the University of Georgia, and the author of "The Selling of The South: The Southern Crusade for Industrial Development."

In the 1930s, Mississippi used municipal bonds to build factories in hopes of luring garment and other industrial manufacturers from New England and the Midwest. This practice spread throughout the South after World War II. "They'd go after anything they could attract," says Mr. Cobb.

By the 1970s, the South's success in recruiting everything from auto plants to tires and chemical industries prompted northern states to get in on the incentive game as well.

Over the past decade, states have changed their incentive programs to focus on importing higher-quality jobs in higher-paying industries like pharmaceuticals and high technology. Missouri's Quality Jobs program, for instance, gives additional incentives to high-tech industries such as pharmaceuticals or software firms.

Also, many incentive programs give more benefits to companies willing to locate in economically depressed areas. According to a 2003 study by Good Jobs First, at least 43 states had quality standards affixed to their economic-development programs, up six from 2000.

For all the recent reforms, critics of economic-development programs charge most subsidy agreements are still too generous, favoring corporations over taxpayers.

In some cases, the critics acknowledge that the programs are good at tying incentives to performance -- but they leave other taxpayers paying for a larger share of public services. As companies expand, they create demand for more employees, which in turn creates a need for things like more teachers and road workers to fill potholes created by commuters.

"If a company isn't paying its fair share of taxes, the burden will either fall on other taxpayers or the quality of services will go down, or some of both," says Greg LeRoy, executive director of Good Jobs First.

Critics also argue that companies can still easily play one city or state off another to get the lowest taxes possible. And, they say, most clawbacks are too porous.

"They're written too broadly and enforced too weakly," says Rachel Weber, an urban-planning professor at the University of Illinois at Chicago.

Ms. Weber points to Ohio, where some incentive agreements allow for companies to wriggle out of job-creation goals if they can show market conditions have soured. Missouri has a similar policy that allows the state to waive clawbacks if the company can't add jobs because of "an unforeseen event out of the company's control."

Not a Top Priority?

Site-location consultants say economic incentives come behind lots of other considerations when companies make decisions about where to put their business. Dennis Donovan, a principal at site-selection firm Wadley-Donovan-Gutshaw Consulting in Bridgewater, N.J., says way up on the list are things like the size and education of the labor force, local infrastructure such as telecommunication lines and transportation options like ports, roads and rail.

"We start taking a look at incentives when we're at a large list of 10 or 12 [sites] and usually it's not going to have an impact on our final three or four," Mr. Donovan says.

For all the criticisms of incentive plans, advocates say clawbacks represent progress in making the deals more equitable for cities.

"No one can predict or guarantee economic conditions, which will ultimately determine the long-term viability of any business venture," says Jay Biggins, executive managing director at Biggins Lacy Shapiro & Co., which represents companies in negotiating incentive packages. If a project doesn't meet expectations, and a clawback becomes necessary, Mr. Biggins says, "that's the system working."