The Bad

By The Economic Development Curmudgeon

In my professional life the two sources of information regarding tax abatement effectiveness seemed to issue from either Think Tanks/Institutes whose membership and revenue base was drawn from labor unions, or from academia. Conversely, in response, practitioners of local economic development, one after another, would counter any criticisms and outrage from academia or the Institutes with our own job surveys which conclusively demonstrated the effectiveness of their programs. Unfortunately, no one, except the firms we assisted, believed these surveys and in any case economic developers quickly learned that anyone asking whether or not tax abatement works was asking a question that promised nothing but trouble. The core of the issue seemed to be how to measure whether or not tax abatement works to the satisfaction of those concerned.

Economic developers quickly learned that anyone asking whether or not tax abatement works was asking a question that promised nothing but trouble.Virtually everyone, however reluctantly, agrees that tax abatement, in its various forms, is not only a longstanding core economic development tool, but is very widely used across regions, states and even nations. Many will further concede that the use of tax abatement is actually growing. The mystery, particularly for academic and national research institutes, seems to be why tax abatement is so core and pervasive when it obviously should be eradicated due to its inherent, proven, and blatantly obvious ineffectiveness, inefficiency, and injustice.

But let’s stop for a moment and ask whether, in fact, tax abatement has actually been proven to be ineffective, inefficient, and unjust.

In this Issue Section, “The Bad”, we will critique two excellent articles which are, we think, well regarded and insightful. “The Bad” does not refer to the quality of the articles; on the contrary. Rather it is the perspective regarding tax abatements and incentives which, in our way of thinking is reflected in their research. Both articles, we suggest, do not like tax abatements at all and in the most perfect of worlds, they would go away. But they know tax abatements and incentives exist and they are trying to understand why. Tax abatements are BAD, but they are out there and jurisdictions, if anything, are using them more and more. Why?

Why Do Jurisdictions Abate Taxes? Are They Stupid?

The first article, Ann R. Markusen & Katherine Nesse, Institutional and Political Determinants of Incentive Competition, a chapter in Reining in The Competition for Capital, W.E. Upjohn Institute for Employment Research, Kalamazoo Michigan, 2007, pp.1-41.

The chief consequence of incentives and tax abatement is enriched corporate coffers and impoverished tax payers.Markusen and Nesse (M&K) move beyond the traditional or, in their words, customary academic approach regarding tax abatements and incentives. The customary approach, which constitutes a significant share of the academic and Think Tank literature, typically employs a micro-economic (single program, single state, specific project) cost/benefit analysis to calculate a cost-benefit ratio and estimate the level of costs/benefits from which evaluation of the tax abatement’s effectiveness can be determined. Most of this literature arrives at conclusions overwhelmingly non-supportive of incentives and their core component: tax abatement. As discussed in more detail in “The Ugly” section of this issue, this customary approach frequently views incentive packages and tax abatement decisions as a negotiation between government and private firms. This negotiation usually is unequal as firms are able to negotiate either “generous” deals or simply get a deal which in no meaningful way affects their decision-making and hence is wasteful and inefficient to the community making the deal. The chief consequence of incentives and tax abatement is enriched corporate coffers and impoverished tax payers.

Moving from its findings regarding the specific failed “deal”, incentive package, or abatement program, this customary literature often extends its findings and conclusions nationally to characterize and estimate incentive expenditures and tax abatement programs for all fifty states and their communities. Finding the single program/type of incentive deficient (more precisely inefficient) researchers using this approach frequently conclude their analysis by roundly condemning the practice of incentives and tools associated with tax abatement throughout the nation and suggesting remedies for their eradication. The customary literature seems to have proven to its satisfaction that tax abatements and incentives do not work and should be terminated.

In fact, the tax abatement tool is more widespread than ever.M&K observe that this literature, despite its two decade ascendency, seemingly has had little, if any, real impact on the actual real-life practice of incentives and tax abatements. In fact, the tax abatement tool is more widespread than ever. M&K describe this phenomenon as a “mystery”. Why do states and communities continue to use these failed tools?

The authors suggest the following factors account for the continued, now expanded use of a demonstrably failed and proven ineffective tool:

1. Depreciating transportation and communication costs which allow capital to be more mobile and raise, if ever slightly, the prominence of taxes in the firm’s cost structure;
2. Vertical disintegration of firms which permit component mobility of formerly geographically integrated companies;
3. Rise of the site consultant industry;
4. Delegation (or devolution) of economic development powers to sub-national units of government (chiefly applying to non-USA); and
5. “Political calculus” of participating governments.

It is in the last three of these factors that M&K depart from the customary approach and push into new, and for us, interesting territory. We shall therefore focus our attention on two of the last three factors in this review. We will not discuss the fourth factor, which they label devolution, because it is not critical to U.S. local economic development since the U.S. economic development function and powers have arguably been devolved since 1789. Devolution is inherent to our federal system and, à la Dillon’s Law, to our cities, towns, and counties. Accordingly, this review shall concentrate on M&K’s third and fifth factors: the site consultant industry, and the political calculus of governments which participate in incentives and tax abatements.

It Ain’t All Numbers: Politics Rears Its Ugly Head?

Cost/benefit calculations take time and require data that firms do not always have and will not provide willingly if they do haven it–and if they did provide the data, it wouldn’t be believed anyway.The ED Curmudgeon must confess that he agrees with M&K’s inclusion of non-micro economic factors, and the stepping aside from the customary literature’s virtually exclusive focus on constructing fragile cost/benefit calculations and estimates. The serial tax abater’s experience suggests that in reality governments have NO access to the proprietary data required for these calculations and estimates to be reasonably accurate, nor sufficient time or inclination to construct a real cost/benefit ratio previous to deal consummation because the sad reality is that any potential competing municipality could say “come on down, have we got a deal for you”. Cost/benefit calculations take time and require data that firms do not always have and will not provide willingly if they do have it – and if they did provide the data, it wouldn’t be believed anyway. Also, any such data once available to the jurisdiction will ultimately become public or be leaked and that means calculating a cost/benefit ratio in a leaky fishbowl.

M&K suggest that although it has been proven that taxes are “very far down” in the cost factors that matter to mobile firms, such firms are “in a position to extract concessions … from regions in the negotiation process” (p.11); in other words, firms don’t really want or need tax abatements, but since they are in such a powerful negotiating position vis-à-vis the jurisdiction, they might as well seize them while the getting is good.

That they are able to do so is due to the rise of the site location industry which has “standardized the way large corporations approach sub-national governments” (p.11). M&K assert the corporate relocation process has been redefined by the emergence of the site location industry (site selectors, site location print media, and consultants). The industry works both sides of the negotiating table, but its most basic loyalty almost always lies with the corporation as “they earn their fees on commission basis. The higher the tax break or subsidy package extracted, the higher their fees”. (p.12)

It may come as some surprise to M&K that this editor partially agrees with their perspective on the role and importance of the site selector industry. To a considerable extent site selectors have standardized the relocation process by impressing on local economic developers the importance of and the specific content and format of demographic, occupation, and location data/advantages, which should be readily available to all interested parties. Also, site selectors accelerate and intensify the negotiation process inherent in relocation and incentive packages. Certainly many site selectors are on both sides of the table, and while it probably can’t be adequately proved, the suspicion that site selectors as a whole tend to work for the corporation is not unreasonable.

Our major qualification to M&K’s position is that, again unproven, most tax abatement/incentive packages do NOT include or involve representatives from the site selector industry – only a minority of relocations, admittedly highly visible, very expensive, inter-regional/state relocations of relatively large corporations usually involve site selectors. The site selection industry’s rise only marginally impacts the widespread prevalence and growing use of tax abatements and incentives. It is another issue, again unproven and unexamined, as to whether their involvement increases the cost of these incentives.

Politics Has Got to Be More Than This!

Politics and political actors affect, and make, tax abatement/incentive decisions.The final factor postulated by M&K, political calculation, is their most interesting and important contribution to an understanding of tax abatement. Mostly lost from the academic literature after 1990 was the recognition that politics and political actors affect, and make, tax abatement/incentive decisions. The micro/macro-economic paradigm or the “customary literature” which has dominated the local and economic development literature for the last few decades has largely deleted politics from academic analysis or reduced it to some amorphous, insidious interest group such as the always evil dark force: the Darth Vader led growth coalition (otherwise known as FIRE to non-ideologues).

M&K review selected research (almost all of which is pre-1995) which assesses the effects of politics on incentives/tax abatement. From this research they offer a variety of reasons why politicians seem disposed to favor tax abatements “even when they are risky, unnecessary, damaging to the fiscal future of the locality, displacing or place extraordinary burdens on constituents to fund future services” (p.15); these include:

• The growth coalition,
• A regional service class,
• A desire by politicians to be reelected which is enhanced by name recognition and political contributions, ribbon cutting ceremonies,
• Lastly, politicians may “want to be seen as proactive in economic development matters and fear nay-saying will provide fodder for opponents … or saddle the region with a bad reputation among site consultants…” (p.15)

This is not a very flattering view of what motivates politicians to become associated with tax abatements and incentives, yet, it does not accuse them of outright corruption or criminal stupidity. There is much more that could be said regarding politics and incentives. We are, however, content to observe that whatever the authors believe underlies involvement by political actors in tax abatement and incentives, the ED Curmudgeon applauds M&K for injecting politics into incentive and tax abatement decision making.

These authors are no lovers of incentives and tax abatements, but they open the door to dealing with the mystery of why incentives/tax abatements are used with ever increasing intensity. Their answer is politics.Of interest to some of our readers may be M&K’s review of several academic approaches to incentive competition. They argue that this literature can be characterized as being in one of three types or categories: (1) the Tiebout-type models which are usually supportive of tax abatement and inter/intra-municipal competition in incentives because “it sets up a competition among units of government for mobile capital” and which is opposed to any attempt to regulate or eliminate this competition; (2) a second type which argues that the incentive competition induces inefficiency into corporate relocation/economic development in that it distorts the location of productive capital from what it would have been in the absence of the incentives. This type (labeled the prisoners dilemma and is reasonably compatible with the previously described customary literature) recommends the elimination or curtailment of incentives; (3) the third category are those who argue that sub-national governments, having authority and responsibility for economic development (and incentives/tax abatements) often find themselves approving excessive incentives due to “asymmetries in the market for jobs “ (site selectors, etc) and these excesses should be regulated. The authors (and the contributors to the book) place themselves squarely in the third camp.

Accordingly, in conclusion, M&K do keep at least one foot inside the customary literature tent. They retain and embrace the negotiation model and their normative concerns (what we describe as values and ideology) which they acknowledge explicitly (equity, environmental quality and efficiency) reflect the often unacknowledged value preferences of the customary literature. These authors are no lovers of incentives and tax abatements, but they open the door to dealing with the mystery of why incentives/tax abatements are used with ever increasing intensity. Their answer is politics.

More Bad

Our second “bad” article which is also excellent and noteworthy is, Gary Sands, Laura A. Reese, and Heather Khan, “Implementing Tax Abatements in Michigan: A Study of Best Practices”, Economic Development Quarterly, Vol.20 No 1, February 2006 44-58, Sage Publications. Succinctly, the article asks the question as to whether or not communities in Michigan follow best practices (as determined by the authors) or not. They studied one program, Michigan’s PA 198 which permits and structures tax abatement for plant rehabilitation and industrial/manufacturing relocation. The program is enabled by state law and jointly administered by the state and localities; final state approval is required. The term is capped at 12 years but communities have discretion to apply for less and there is a two year claw back if the company leaves the area. The database contained abatements over a twenty-one year period (1980-2000). Over that period, 40% of Michigan’s eligible communities participated in the program, but that use of the program was bimodal in that 35 communities granted 44% of the abatements and 209 communities (12%) two or less. The characteristics of high versus low volume users were not assessed but comments suggest high population area (Grand Rapids, Detroit and Holland and Holland townships) were high volume.

“There neither appears to be any particular dissatisfaction with abatement practices within communities…nor has there been any trend toward making firms more responsible for investment decisions…”As one might expect, most communities were in various ways deficient in adopting or applying these best practices. For specific findings the reader is urged to consult the article, but in general the survey discovered that many (32%) communities do not really have guidelines (although 40% did); those that did inconsistently followed them; and most did little to evaluate or enforce any claw backs. Deserving of special note was evidence which suggested to the authors that abatement requests were seldom turned down and were almost automatic. SRK state that communities themselves did not measurably alter their policies over the twenty years, 11% relaxed their standards, only 4% strengthened them, and they conclude by observing “there neither appears to be any particular dissatisfaction with abatement practices within communities…nor has there been any trend toward making firms more responsible for investment decisions…” (P.50).

Still, in their survey analysis SRK found some support for the finding that the heavy volume users of tax abatement actually were (1) consistent in heavy volumes throughout the twenty plus years, and (2) were most likely to employ good best practices (P.51). The authors further assessed factors which were included in the community requirements such as quality jobs and jobs/training for distressed workers for instance. In general, wealthier communities were more likely to follow best practices (P.52) as well as growing communities (P.53). The ED Curmudgeon injects that in his research for this review he uncovered consistent support that wealth and population growth are associated with progressive use of tax abatements.

Nevertheless all too predictably, SRK concludes by observing that their survey and analysis “suggests far more bad news than good for abatement practices in Michigan” (p.53).

That a majority of municipalities never evaluate the performance of firms granted abatements suggest that firms can ignore any conditions that are placed on them, and that claw backs or other reparations will never be assessed because the community lacks performance data. And because there has been little change in abatement practices over time, communities are not likely to start embracing model policies in the near future. (P.53)

The results here suggest that individual local governments are unlikely to seriously address these equity questions (inherent in tax abatement literature) (P.54)

This review of the Michigan industrial tax abatement program suggests that even if incentives continue to be widely used, modest changes could be made to increase their effectiveness and efficiency. Such changes, however, are unlikely to occur if discretion is retained at the local level. (P.55)

Best Practices Can Improve the Quality of Tax Abatements?

We are less interested in critiquing the SRK’s conclusions because we are more concerned with what SRK does with them. Having observed that best practices are not consistently followed in Michigan, the authors blame and decry the communities and their abuse of the discretion allotted them. The problem and blame lies at the community level. The Curmudgeon does not agree.

Having observed that best practices are not consistently followed in Michigan, the authors blame and decry the communities and their abuse of the discretion allotted them. The problem and blame lies at the community level.The basic problem he feels is that SRK’s definition of what constitutes best practices is, from the Curmudgeon’s opinion, anything but fair and objective from the perspective of the community. Accordingly, let’s look with some depth at what these best practices are, how they were developed, and then offer our reasons why the locals did not follow them consistently or well.

SRK selectively review some academic literature and cull three “recommended practices” which should improve abatements and render them more effective. These best practices are held to be logical derivatives “From a policy perspective, {of} what should local governments consider before they grant tax abatement”.

It seems the authors draw their findings from a literature review. In that some of the literature suggest that jurisdictions in several identified situations can efficiently employ or, at least, justify incentives and abatements, the authors suggest that success/justification in those instances can be attributed to the following factors or circumstances:

• high fiscal stress or;
• Where marginal costs of doing business are critically high, or;
• In limited or focused geographic areas, for firms that serve an employment or site need drawn from local population needs.

SRK assert that to improve the quality and appropriateness of using tax abatements “that processes need to be in place to assess whether these {the above listed} conditions are met.” (pp 48-49). Their best practices, therefore, reflect the authors’ conceptualization of conditions where tax abatements can be used. These situations can be reliably known only if best practices are adopted; and, if the best practices are not adopted and faithfully administered then the use of abatements is not justified or at least the quality of the benefits derived from tax abatements are diminished.

These best practices are:

1. assessment of costs and benefits before granting abatement;
2. attachment of strings or performance requirements (claw backs) to the award; and
3. evaluation of the outcomes of the abatements granted (p.45).

The authors implicitly assume a consensus exists which supports these best practices and they then survey the municipalities to determine the extent to which these best practices were in fact practiced.

Whose Best Practices Are These?

Academically derived best principles need to have been adopted into law and practice before we can hold economic developers accountable to them.But despite their implicit assertion these best practices should be observed, the editor is unaware that this best practice consensus was incorporated into either the law/regulations of Michigan or, if we are to extend this analysis nationally, consistently required in the other forty-nine states. To our best knowledge, these best practices were not required by enabling state or program legislation/guidelines. Rather, these best practices (even if we agree with them in principle) appear to be like natural law, inherent in nature and known to all humanity. In short, academically derived best principles need to have been adopted into law and practice before we can hold economic developers accountable to them. It is fine to advocate for such best practices but, failing adoption by responsible authorities, their absence does not warrant the potential conclusion that tax abatement cannot be justified.

There has been no dialogue; Michigan practitioners have not been consulted as to whether or not the above constitute THE best practices they should follow. However reasonable they may appear to the reader (or not), they are best practices devised by those outside the profession, informally superimposed on existing law and program requirements and, if not adopted or followed, are used as additional proof of the impropriety (and ineffectiveness) of tax abatements and incentives.

Best Practices?

Despite this rather ominous start, SRK are trying to understand the use of incentives and tax abatements and suggest “best practices” can both stimulate and justify incentives. Indeed their article abstract asks “is it possible to allocate abatements in a way that increases the likelihood that tangible benefits will result?” (p.44). The problem we obviously have in this review is how one can fairly construct these best practices and at least begin to forge a consensus to be reflected in law, enabling statutes and professional guidelines.

A larger more fundamental issue with claw backs concerns what standards or criteria a community should include in a claw back agreementThis will not be an easy task. As a start, we will briefly critique the three best practices suggested by SRK.

SRK quite reasonably state that “at a very minimum, a best practice would entail a policy spelling out guidelines or requirements to determine whether an individual firm should receive an abatement” (P.49). This is an eligibility policy which specifies who can get tax abatement and why (and who cannot); this is an eminently fair and good starting point and is their first best practice.

How this initial eligibility policy statement gets translated later in the article into a cost/benefit analysis performed previous to award of abatement is NOT discussed in the article. Discussed or not, the leap from eligibility policy to pre-decision cost benefit analysis is made. At various points in the article cost/benefit is identified and treated as if this were the definition of an established policy. We, as already mentioned, have great issue with a cost/benefit analysis for several reasons, but the rationale as to how an eligibility policy must either be, or include, a cost/benefit analysis is simply not presented by SRK. It is simply included, somewhat mysteriously, as a best practice several pages earlier.

The academic community has not appreciated the complexity of adopting their remedies at the street level.The second best practice is “the attachment of strings or performance requirements”. These are “sanctions” if the conditions of the abatement are not achieved. Commonly referred to as claw backs, these sanctions compel the recipient to carry out satisfactorily the terms of the abatement. We can understand that firms and site selectors are not especially thrilled with a claw back (it jeopardizes predictability of the benefit), but certainly it is the right of a community to ask for them and to include them in a tax abatement agreement. It, however, is also the right of a community to NOT ask for a claw back. Therein lies at least one problem with claw backs. Some communities will employ claw backs, others will not and then the existence of a claw back itself will become a form of incentive and abatement.

A larger more fundamental issue with claw backs concerns what standards or criteria a community should include in a claw back agreement: number of jobs or dollars of capital investment, quality jobs (however defined), and jobs for the unemployed or investment in neglected/distressed geographies? For how long do jobs have to exist, facilities kept operating? None of these are self evident and it is highly likely that considerable diversity in adopting such standards among communities and states will occur. Whether these standards will sort out investments and jobs by community need is possible to some extent, but unpredictable.

In conclusion, we do not criticize the effort to discern and apply best practices to the exercise of tax abatements and incentives. We should, however, recognize why they have not yet achieved consensus. The devil is in the details and so far the academic community has not appreciated the complexity of adopting their remedies at the street level. In addition, the consensus found on campus throughout the nation is not as easily replicated in our cities, towns, and regions. Tax abatement is a clumsy tool, and used badly can leave damage in its wake. This lack of consensus, however, is the very reason why our founding fathers created federalism: to allow for diversity and diverse perspectives. Crushing federalism may solve the evils of tax abatement, but at what cost to our Republic.