How did corporate incentives in the U.S. get so big? A trilogy

PART I: WHAT ARE INCENTIVES?

PART II: WHY ALL THE INCENTIVES?

PART III: HOW TO TALLY THE IMPACTS?

In the previous two parts of this blog, I wrote mainly about the rationale for incentivizing/subsidizing development projects and provided current snapshots of both the use and reporting of tax incentives. This last part focuses on the process and impact, not just ex poste impact of live projects but also impact predictions during decision-making. In the past, I have published some impact analyses using actual data -- specifically the impact of property tax abatements on school finances -- so here I would stay with more general factors to consider when conducting cost-benefit analysis.

Let's start at the beginning: state governments enable certain local governments to abate taxes for economic development; these aren't exactly tax breaks you might claim on returns, but rather companies typically go through an application and review process, during which impact analyses and negotiations may be conducted. The typical arrangement is for approved applicants to pay less taxes for a number of years in exchange for a certain number of new jobs paying certain wages accompanied by certain levels of investments.

To predict or evaluate the impact, convential economic analyses would look at new jobs, values, and tax revenues that would be or have been, respectively, generated directly and indirectly through multipliers. Given how key all these indicators are for deciding whether tax dollars are being put to good use through incentives, you would be surprised that many programs don't require the agency to disclose how many jobs are promised and created. Consideration for the added value implies that the industry matters -- that governments get different returns from subsidizing different sectors or type of industrial/commercial activities. For example, subsidizing the films and sports stadiums generally doesn't pay since often companies/activities leave after a production or event, and there have indeed been many studies (example) showing the bad business of these particular business incentives.

Last to consider is the tax revenues. This figure gets us closer to figuring out the social costs of tax incentives, if we can contextualize it in local finances and public service economics. Here we can pinpoint a source of the power asymmetry referenced previously between large corporations and community planners or advocates. For most companies, property tax is indeed a huge item on the bill, but it still accounts for a very small percentage of the total operating expenses. Meanwhile, half a million dollars in foregone revenues could go a long way in a poor community. Most school districts depend on property tax to provide often the most expensive public service, K-12 education, that tax abatements could cause serious burden. Opportunity cost analysis often converts the cost figure into the number of teachers that can be hired or extent of infrastructural upgrades.

There is also a spatial dimension and a temporal dimension to the story. Both the use and impact of tax incentives are geographically uneven. Research has shown that distressed localities are particularly driven to lure investment with incentives, but if the deal doesn't pan out, abating taxes won't help with the fiscal stress. For example, Kansas City Public Schools is openly opposed to the Missouri city's incentives that disproportionately hurt disadvantaged kids. And if things do work out economically, benefits tend to spill out into neighboring jurisdictions who did not pay for the investment. In some cases, tax abatements have been linked to increased gentrification. In terms of time, proponents of tax incentives would argue that these investments will pay off in time, but we are often looking at 20-30 years of breakeven period, and that's many students affected in the meantime.

All this is to say that for all the incentives we use, we do not scrutinize them nearly enough. There are many factors beyond just jobs to consider, and even jobs we don't know half of the story due to lack of transparency. What we know is that some school districts are feeling the harm, and that implications for social equity are not promising. To make incentives work better and hurt less, it's important that governments establish independent auditing committee to evaluate the net impact, protecting certain critical streams of funding (like the one for public education) from abatements, and removing barriers to open information.

How did corporate incentives in the U.S. get so big? A trilogy

PART I: WHAT ARE INCENTIVES?

PART II: WHY ALL THE INCENTIVES?

PART III: HOW TO TALLY THE IMPACTS?

Decades of research has shown that the economic impacts of tax incentives are mixed at best, and emerging research is showing that the social costs of tax incentives can be enormous. So then begs the question, why do it: Why risk abating taxes on stressed budgets to attract or retain a firm that already made up its mind to stay? Why risk subsidizing with tax dollars a project that may or may not deliver the promised benefits - instead of investing in something that generates sure, if longer-to-materialize, returns, like human capital.

These are not meant to be rhetorical questions; they are important things to consider when deciding to approve an incentive and determining how the incentive agreement needs to be structured. how long to tax a property at, say, half value for, or what to do if the company falls short on creating jobs or generates some other kinds of harm on the surrounding communities. PART III of this "trilogy" will suggest outcomes to consider.

So why incentives? The answer you're likely to hear from experts is "it's political (rationality)." It hardly matters that academic research doesn't support signing away this much tax revenues, if it makes sense for the decision-maker from his/her perspective to do it, and particularly when the analysis is ambiguous (it's generally difficult in social sciences and policy studies to isolate interventions for costs and benefits attribution). Only when deals fall apart spectacularly, like Foxconn in Wisconsin a few years ago, or when communities push back in a way that attract media attention (e.g., Queens, NY re: Amazon HQ2, East Baton Rouge, LA re: ExxonMobil, etc.) is there a strong enough reason to go against the prevailing currents at the individual, interactive, and institutional levels:

Individual - For the elected official, almost any deliberate action to improve things makes more sense to pursue than inaction. Signing a tax abatement agreement with a prominent firm carries a host of benefits. I cannot do justice here to this book by N. Jensen and E. Malevsky Incentives to Pander: How Politicians Use Corporate Welfare for Political Gain. The authors argue that when "global competition for capital meets local politics," the result is personal drive to take credit for signs of economic growth, and pursuing economic growth strategies is a ready way to do it, regardless of whether the exact strategies are called for.

Interactive/social - Competitive dynamics, perceived or actual, permeate a decentralized governance system. Places compete, and sometimes quite openly, like those that bidded for the second headquarter of the e-commerce giant, Amazon.com. You almost never think of competition going the other way around (i.e., firms competing for places to locate), even though many incentives are competitively structured. Game theory suggests that power and information asymmetry can lead rational agents to make suboptimal rational choices in the absence of trust and coordination. The analogy of prisoner's dilemma is often applied, like in this piece by the Mercatus Institute. There has been a lot of research by political economists to address the problem at multiple levels. Some states are figuring out mutual or multilateral ceasefire options in hopes of ending these costly incentive wars.

Institutional/systemic - Arguably, deindustrialization of certain manufacturing cities, neoliberal restructuring, and the fervent pursuit of targeted, market-based strategies under the Clinton administration (i.e., all the special zones) left fertile soil for incentives to grow. As industries change, so do subsidy types. Nowadays, problematic ones proliferate, like sales tax rebate for data centers which eat up a lot of the grid and need few people to man, or property tax abatements for market-rate apartment buildings... imagination is the limit.

How did corporate incentives in the U.S. get so big? A trilogy

PART I: WHAT ARE INCENTIVES?

PART II: WHY ALL THE INCENTIVES?

PART III: HOW TO TALLY THE IMPACTS?

State and local governments in the U.S. spend around $50 billion dollars a year to subsidize private businesses – and that’s only what we can estimate and extrapolate based on limited data. Two issues are at stake: 1) the enormous costs to revenues – some reserved for critical social provisions and 2) the secrecy surrounding of the heftier subsidy deals.

A troubling power imbalance exists between the players in the incentive arrangement that stand to gain and people impacted by the revenue diversions. Some recipients are smaller operations that needed the government incentive to jumpstart a modest investment project, but most incentives are often proportional or even disproportionately regressive in bias of large corporations and upward of billion-dollar investments. Furthermore, even the most successful investment entails opportunity cost.

The goal of incentivizing development is always some form of economic growth, but projects such as refineries and data centers employ few workers, and it typically takes decades for the new revenue to offset the foregone revenue, and by then – many more projects will have been approved to receive similar benefits, potentially leading to cumulation of fiscal stress.

How did all this begin? The first such incentives popped up in isolated places starting in the 1930’s. The latter half of the twentieth century saw exponential growth in frequency of their use and size of the awards, even accounting for inflation, and expansion to cover almost every corner of the country. The cause for this enormous growth becomes apparent after only a little digging: agencies that administer the subsidies, subsidy recipients, landowners, banks and lenders and brokers, and – mostly importantly – industrial site location consultants that put pressure on governments to create and maintain a good “business climate,” meaning decreased regulation, weak unionization, and/or lower taxation. All these players add up to a powerful growth machine that can easily steamroll community opposition.

Corporate incentives take so many forms – some of which very complicated for people without a finance background to parse out, which strengthens the persuasiveness of a logically fallacious narrative (“incentives create jobs”) and difficulty in tracking down the costs. Cash payments are fairly straightforward and often take the form of “deal-closing” funds and reimbursements for training workers. Much bigger than these cash payments are the various tax incentives – tax abatement, credit, rebate/refund, and lowered assessment value – resulting in lower taxes owed. Even bigger than these, and unfortunately the most poorly disclosed and tracked are more confusing financing instruments such as industrial revenue/development bonds (IRB/IDB), which allow a tax-exempt entity to temporary hold the title, and tax increment financing (TIF), which diverts all revenues gained from the point that the area/zone/district is created to the end of the contract (typically 20+ years) to pay for infrastructure development that does not always benefit the people and sometimes directly pay-as-you-go reimbursements back to the developers. (descriptions sourced from Good Jobs First, a D.C.-based nonprofit watchdog + research organization)

Disclosures are scattered and the quality depends on state statutes. Texas is the most transparent of all states (albeit about a very damaging program that expired and got resurrected in a different form), and makes available to the public not only annual costs to state and school districts in this case but also application packages showing documents at different stages of the incentive approval process via the Comptroller's site.

Other states fall short of Texas's disclosure of this particular incentive program by varying degrees. Some invoke confidentiality clause, in their annual costs report, to hide the identity of recipients or nature of subsidized projects, or just not disclose any costs at all despite the enormity of fiscal and economic impact.

Local governments are a mixed-bag – ranging from Chicago’s meticulous record of its extensive TIF and Montgomery County’s (MD) annual tax expenditure reports, to virtually no information at all in many places on clearly active agreements. Freedom of Information Act Requests (FOIA) help sometimes, but the process of filing them is time-consuming.

Finally, in only a few states are the costs broken down by jurisdictions – county, city, school district, etc. And still, the reported figures are often not reliable, and humongous chunks of lost revenues, particularly those through tax increment financing, remain unaccounted for.