The Ugly

Any reader of the articles in “The Ugly” knows pretty quickly where their authors stand on tax abatement and incentives. If the title of the articles does not suggest a conclusion, the opening paragraph of Alan Peters & Peter Fisher’s, The Failures of Economic Development Incentives”, Journal of the American Planning Association, Vol.70, No 1, Winter 2004, gives it away very bluntly, at least relative to academic research:

The provision of business incentives…, one of the mainstays of economic development policy…has been the target of the most intense criticism. Indeed, there are many prominent critics who believe that virtually all incentive programs should be banned. Nevertheless, indications are that spending on incentives has continued to expand. (P.27)

For Peters and Fisher (P&F) the “fundamental, yet unresolved question” regarding tax abatements/incentives is whether they are a cost effective strategy for achieving economic growth. To answer this overarching question, P&F construct the following evaluative criteria:

  1. Do incentives cause states and localities to grow more than they would have without incentives?
  2. Is the growth generated providing net gains to the poorer communities or poorer people or is it zero sum?
  3. How costly are incentives relative to other alternative economic development policies?

Incentives include: property and sales tax abatements and credits, tax increment financing, corporate income tax exemptions and credits, grants, loans and loan guarantees. The key concept for inclusion as an incentive is that the benefits go to a business, not a worker or work seeker. They estimate, through citing previous research, the total cost of incentives to be $50 billion in 2002. That $50 billion will serve as the benchmark from which they will derive their conclusions.

Cost/Benefit Analysis: Whose Side is It On?

We need to suspend for a moment any further description of the article and instead at least partially deal with some issues raised thus far. First, one cannot ignore the value-laden perspective from which this article and a goodly number of the “traditional literature” on incentives and tax abatement

are built upon. Whether the reader agrees with this point of view or value position is quite beside the point; there is a deeper well from which this literature, certainly this article, is drawn – the well of ideology. Whether or not the authors are sufficiently open in acknowledging their political position is again for the reader to decide, but a fair and reasonable conclusion can be made that neutral observation may not be a cornerstone of this article, and if this article is indeed reflective of a larger paradigmatic literature on the topic, then the overall approach is heavily impacted by values and an inherent or built in political approach or ideology.

Secondly, the words “cost effective” betray an approach/methodology to answer the questions posed. These words are sufficient disclosure that a cost/benefit calculus will be devised from which quantitative/monetary answers will emerge. Fortunately this is not the time to derail our review with an extensive (and boring) micro-examination of cost/benefit analysis, its methodologies, and its ability to actually calculate a ratio of costs to benefits. In any case we shall discover, as this issue’s tripartite review unfolds, that the academic tax abatement/incentive literature of recent vintage centers around the micro-economic cost/benefit approach.

This crystal ball enterprise can easily become crushed glass when it confronts the diversity and variation one would logically believe exist across regions in our federal republic.Yet we do know that in order to arrive at cost/benefit’s monetary/mathematical conclusions, any researcher must make assumptions (interest rates, discount rates, rates of growth, etc.) and must also calculate future costs and benefits, all of which is obviously a risky enterprise in and of itself. Given our earlier observation (non-neutrality) one might be wary as to how objective and fair these assumptions utilized may be and whether or not they are fully disclosed. In any case, culling from a potential literature of perhaps a hundred studies, P&F select several and in effect incorporate the findings of these selected studies as the basis of their assumptions employed in this article’s cost/benefit calculations. I must say that while reading this article’s literature/assumption section, several very loud warning bells rang in the ever beclouded brain of the Economic Development Curmudgeon who edits this Journal.

Frankly, the Editor must confess uneasiness with cost/benefit analysis based on one or two states/communities or programs no matter what the underlying values of the researcher are. These crystal ball methodologies make assumptions which imply certain conclusions and extend them across the entire universe of states and programs. This crystal ball enterprise can easily become crushed glass when it confronts the diversity and variation one would logically believe exist across regions in our federal republic. Nevertheless, P&F do assume that findings from selected state/program research can be used to calculate national rates and past findings can be simply extended across programs, boundaries, and time periods.

Definition of Incentives

A third observation reflects our concern with the definition of incentives commonly employed in the traditional tax abatement/incentive paradigm. There is such distaste for these programs that researchers see no meaningful distinctions among incentive programs; in P&F’s article the common thread is that they apply to business not workers. As Gertrude Stein would say, if she were to comment on incentives: An incentive is an incentive is an incentive.

If the rationale for the inclusion of all these disparate programs into an amorphous mass called incentives is that they benefit a business, not a worker/the unemployed, does it imply that assistance to corporations is by nature evil, inefficient or abusive, but assistance to people is good, efficient and justifiable? Perhaps this distinction is true, moral and valid, but it still further underscores our concern that there are serious value/political preferences permeating this approach to tax abatement/incentives.

Can individual programs, designed in various ways, intended for different clients for all sorts of purposes/goals be simply collapsed into a one size fits all category called incentives?Can individual programs, designed in various ways, intended for different clients for all sorts of purposes/goals be simply collapsed into a one size fits all category called incentives? Lumping all forms of incentive (especially grants and loans) into a large amorphous package labeled “Incentives” implies more coherence and internal logic than actually exist. All these forms of “monetary” incentives can be quite dissimilar not only in structure and eligibility, but also in purpose. Usually, since these programs are set up by each state, one should expect a considerable diversity of programs for specific purposes and clienteles, each operating in vastly dissimilar geographies and economies. Some may actually be justified in a cost/benefit analysis, but are lost in a mass of possibly irrelevant data.

Communities Are NOT Identical To Each Other

Our next initial concern involves the author’s construction of a $50 billion cost estimate for all incentives nationally (it is derived from 1996 and 2002 articles, the latter by the authors). This contrived number, even if believed to be conservative, could strike one as being a bit loosey goosey for such an important function as the ultimate benchmark used to support or reject the findings. Also, determining that because the cost side of the equation in a given year is larger than the benefit number of that year fails to prove that any component program within the aggregate has in fact failed or succeeded. Rather, it can only suggest that as a whole, they did not achieve financial breakeven. Financial breakeven is a dim measure of program effectiveness.

In Any Case, Resuming the Review

As stated earlier, P&F posit three questions which serve as criteria for determining whether or not the incentives as a whole succeed or fail. The derivation of these three questions arises from their “meta-review” of the pertinent literature which contains some interesting and informative assessment of selected articles. We shall now turn to presenting the answers to these questions and, as we are wont to do, inject our blatherings as we deem warranted.

In regards to the first question (do incentives create jobs or investment), P&F, after the better part of three pages of often conflicting conclusions, question the data, types of incentives, and methodologies of various studies they have selected and, with frustration, arrive at the following conclusion:

The upshot of all this is that on this most basic question of all – whether incentives induce significant new investment or jobs – we simply do not know the answer (underling inserted). Since these programs probably cost about $40-$50 billion a year [EDITOR injects: this is now a fact, not an almost informal estimate], one would expect some clear and undisputed evidence of their success. This is not the case. In fact, there are very good reasons – theoretical, empirical and practical – to believe that economic development incentives have little or no impact on firm location and investment decisions. (P.32)

Incentives and abatements are just wrong! We know it, you know it – and here is the proof.In the Editor’s words, this statement translates into: “we could not find conclusive evidence that such incentives are effective or ineffective from a literature hostile to tax abatements/incentives and from which we personally selected, virtually all of which use a cost/benefit methodology which is fraught with peril and bias. But not to worry, we really all know that since the review is inconclusive, its inconclusiveness is itself damning of incentives because if incentives were actually successful the literature review would be conclusive. So therefore, the literature indicates incentives are not effective in job and investment creation, but also ineffective for a new, additional factor that we have not discussed at all: firm location.”

A good summary of this line of reasoning, we might suggest, is that incentives and abatements are just wrong! We know it, you know it – and here is the proof.

Definitive Findings?

Moving on to the remaining questions, perhaps surprisingly, the literature reviews which the researchers compile conclude similarly as the first question: “The empirical literature on these questions is fairly skimpy” and “the results have been mixed”(P.32). Their conclusion regarding the second question (is growth targeted to poorer people or geographies?), for instance, is particularly cumbersome:

Let us summarize our argument so far. In most states some portion of a state’s economic development funding will be targeted at distressed areas; some (small) portion of that funding may actually be effective in inducing investment and jobs in those areas; some fraction, and probably not a large one, of those induced jobs (if there are any) will actually go to residents of that area; and some of those newly employed residents may actually be the poor or unemployed we were trying to help. And even this doubtful level of policy effectiveness may be difficult to sustain. (P.34)

What can the reader take away from that summary/conclusion just presented? We are not sure, but somehow it supports their final observations contained in their conclusion presented below:

On the three major questions – Do economic development incentives create new jobs? Are those jobs taken by targeted populations in targeted places? Are incentives, at worst, only moderately revenue negative? – traditional economic development incentives do not fare well. It is possible that incentives do induce significant new growth, that the beneficiaries of that growth are mainly those who have the greatest difficulty in the labor market, and that both states and local governments benefit fiscally from that growth. But after decades of policy experimentation and literally hundreds of scholarly studies, none of these claims is clearly substantiated. Indeed, as we have argued in this article, there is a good chance that all of these claims are false … It seems to us that there is a need for a radical transformation of policy ideas on how we achieve local economic growth. (P.35)

We couldn’t have said it better. Incentives provided to business are wrong and we ought to stop them immediately, even if we can’t provide conclusive evidence.

More of the Same: Just Different

Our second article, Mark K. Cassell & Robert C. Turner, “Racing to the Bottom? The Impact of Intrastate Competition on Tax Abatement Generosity in Ohio”, State and Local Government Review, Vol 42, No 3, December 2010 (PP 195-210), is perhaps the most recent on the topic of tax abatement/incentives. It continues the longstanding literature focus on the value/ineffectiveness/distortions created by the most controversial economic development tool: tax abatement. Using a state of Ohio database of 4400+ Economic Development Zone tax abatements granted during the 1983-2004 period, the authors ask whether local governments offer larger tax abatements to firms if intra-jurisdictional competition increases.

The answer, they state, is Yes. The more local governments compete with each other, the more taxes are abated and for longer terms. They further observe that “when the state economy is growing more rapidly, local government offers smaller incentives” because they are less dependent on revenues derived from firms (P.205). The authors conclude that intra-municipal competition alters the power balance between local governments and private firms, reduces any benefits from siting a firm in the local community, and serves only to increase “the amount of corporate surplus”.

Rather than critiquing the conclusions of the article, we are disposed to use the article to better understand what, we believe, has been a significant academic approach to investigating the effectiveness of tax abatements and incentives: the “negotiation model”.

The negotiation model posits that tax abatements are the result of a negotiation between individual governments and firms. The model focuses upon those variables or factors – in this case intra-municipal competition and growth/decline of the overall state economy – which enhance or impede the negotiating position of the participants. Bargaining power is critical and usually this literature, we believe, assumes and concludes that the public side of the negotiation is weaker, more vulnerable, and predictably comes out poorly to the detriment of citizen, taxpayer and the disadvantaged.

The negotiation model posits that tax abatements are the result of a negotiation between individual governments and firms.There are various types of negotiation models found in the literature. The earliest (and used presently by authors of a mainly “conservative” persuasion) is the Tiebout model which usually concludes that intra-municipal competition yields positive results and that tax abatement/incentives do result in growth for the victorious community. Moreover, the Tiebout model believes such intra-municipal and inter-municipal competition to be economically efficient, more or less rational and non-distortive and leads to an efficient distribution of investment across the overall system. If one draws articles from more conservative institutes and researchers, one can often find examples of this analysis.

Cassell and Turner, however, employ a different negotiation model: the market centered approach which focuses on the competitiveness of communities, the information available to the negotiation participants, and the mobility of capital which further fuels community competitiveness. As stated earlier, researchers using this model often conclude that the community/local jurisdiction does not compete well and comes off poorly.

We have a few items to discuss in regards to this model! First a positive note. We applaud the article for its selection of only one type of abatement: the economic development zone tax abatement. Rather than combining a zillion types of incentives into one large mass, we have a concrete incentive about which we can hopefully reach some better understanding.

Does Tax Abatement Necessarily Rely on Negotiation?

Returning to our more customary negative perspective, however, the ED Curmudgeon is uncomfortable with the basic concept of tax abatement à la negotiation. The Curmudgeon is far from convinced that there is all that much negotiation actually underlying the approval of much of local tax abatement. If one considers the different Economic Development Zone (EDZ) tax abatement processes used throughout the nation, the discretion/negotiation allowed in Ohio is far from universal and may be atypical. In any case, if we are to assume that local tax abatement is a negotiation, allowing jurisdictions some discretion, a more significant effort to prove the concept’s national viability should be made.

For many states the eligibility for EDZ tax abatement and the terms, and formulas by which tax abatement may be granted, are set and standardized by the state. In several states the state itself reserves the right of decision or shares the approval with the community. We will present support for this observation in the review section, “The Good”, which describes the variability in tax abatement throughout the nation. We therefore question an automatic assumption the conclusions of this study apply to EDZ tax abatement nationally.

Secondly, communities which perceive some weakness in their ability to successfully negotiate but which statutorily have the discretion to negotiate may limit their own discretion by approving a policy which standardizes the abatement decision or which applies an automatic level of abatement for each defined project-type. A policy of this nature allocates benefits according to firm characteristics, job and investment level, or even geographic location. There is no real negotiation in the abatement decision, only eligibility and classification determination. Any community that perceives itself disadvantaged by its discretion in negotiations can have a remedy readily available, assuming state law allows.

Who is competing with whom?

It is obvious that communities differ in their size, fiscal and economic condition, and their location as well as other factors. If one proposes to assess the impact of intra-community competition, some of these basic distinctions should be utilized to group competing municipalities into apples to apples categories or classifications. Cleveland competing against Farmersville Ohio (my wife’s home town) is not likely to be a fair fight or would it likely result in weakening Cleveland’s negotiating position. There is too little differentiation incorporated into the article, but to be fair, they do conclude that community size in particular does plays a role – an inverse role in that the larger the community, the less intra-municipal competition seems to affect the amount/term of the abatement. Farmersville’s competitiveness does not lessen Cleveland’s negotiating position.

The findings by Cassell et al. that at least one such factor can affect negotiation leaves open the question of whether other factors can as well. Certainly greater competition among jurisdictions will tend to weaken negotiating positions overall but that truism does not help us really understand who in particular is disproportionately disadvantaged and why. Other factors and distinctions have to be brought into play. But from our experience, arising from having been a serial tax abater in more than one community, there are more subtle differences which can challenge the usefulness of the negotiation model.

Capital may be mobile, but factories and offices are markedly less so. If indeed firms are negotiating location with jurisdictions, they are most likely negotiating a basket of items and to isolate one, tax abatement, as being necessarily dominant must be proven not assumed.Capital may be mobile, but factories and offices are markedly less so. Firms already resident in a jurisdiction can move but might need more than a small incremental advantage gleaned from a competing and neighboring community’s willingness to offer marginally higher tax abatement. If indeed firms are negotiating location with jurisdictions, they are most likely negotiating a basket of items and to isolate one, tax abatement, as being necessarily dominant must be proven not assumed. Given that Cassel’s Ohio study of EDZs found that only 2% of the tax abatements involved out of state relocations and the remaining 98% were either relocated from within the state OR expanded existing locations, the behavior of resident firms overwhelmingly dominates the EDZ abatement process in Ohio and potentially minimizes the effects of intra-municipal competition.

Thus negotiation, to the extent it actually occurs, is therefore not likely to be limited to just EDZ tax abatement. Trained workforces do matter to productivity, and firm cost and locational advantages can negate the bargaining advantage of communities offering more extensive abatements. The negotiation literature incorrectly, we perceive, seem to see firms as footloose and fancy free, able and willing to move for any incremental or even marginal tax abatement advantage. While each project needs not be totally unique from other projects, there are likely to be differences that matter in any negotiation. To the extent these countervailing forces restrict firm mobility, they temper abatement maximization and constrain the damaging effects of inter- and intra-municipal competition.

Swinging for the Fence: Sometimes It Pays to Be Generous?

C&T observe that their data suggests that rural communities are more generous than the big, bruising urban cities. It appears Farmersville would be more generous than Cleveland. This finding provides the Curmudgeon the opportunity to make one final point. The negotiation model assumes tax abatement generosity is negative. After all, if tax abatement to firms transfers tax payer monies to fat cats and bloated profit-making corporations, artificially forced abatement generosity only is a further abuse. Obviously, this abusive generosity can occur, but we would also argue sometimes it makes sense for a community to be generous– if it results in a truly serious opportunity to transform one’s local economy.

Without making too much of a point of it, an unsupported generalization the Curmudgeon would throw out is that much academic literature is not written from the perspective of the overall community or jurisdiction. Academic and Research Institutes/Think Tank research is, in our opinion, a more top-down, overall national perspective where any gains enjoyed by one community are washed out by losses in others. Victorious jurisdictions profit from their victory (unless some cost/benefit analysis proves otherwise); the losses are borne by others. As we will state elsewhere in this issue, this is the cost of doing business as a federal republic.

It is not surprising that rural communities therefore are more generous. They have potentially more to gain if they are victorious. Moreover, their economic and fiscal problems are just as severe to them, as they are to the big, prestigious, more visible cities and large suburbs. Relocating 200 jobs to Farmersville will be visible to every resident and in a community of 2000+ it is not unreasonable to suggest the positives will overcome the negatives associated with the relocation. Abatement generosity in the pursuit of victory is not an abuse of local tax payer funds.

Conversely, some projects, no matter whether they are located in a large urban center or a rural small town, potentially warrant generous tax abatement. The Curmudgeon, given his jaded past, believes that troubled sites, brownfields, key anchors to downtown/town center can merit oversized tax abatements by a willing jurisdiction.

It would seem that one could conclude that each tax abatement ought to be judged on its own merits (cost/benefit if you must), but we won’t make that argument. Rather we simply conclude by observing that there is nothing intrinsically wrong with looking at tax abatement from the bottom-up, from the community’s/jurisdiction’s perspective. After all, the macro tax abatement programs (such as EDZ) and the discretion to abate taxes typically, if not always, originate from empowerment by the state. Jurisdictions are using powers they have been granted. In such a world the reality they use tax abatement to secure an advantage over other competing, similarly empowered communities is from each community’s perspective only right, logical, and even moral. Efficient and effective, however, may be another story?

Comments

No comments yet. You should be kind and add one!

By submitting a comment you grant Journal of Applied Research in Economic Development a perpetual license to reproduce your words and name/web site in attribution. Inappropriate and irrelevant comments will be removed at an admin’s discretion. Your email is used for verification purposes only, it will never be shared.