New Report Highlights Flaws of North Carolina Mega-Incentives
by Kenneth Thomas
New Report Highlights Flaws of North Carolina Mega-Incentives
My new report for the North Carolina Budget and Tax Center, Special Deals, Special Problems–An Analysis of North Carolina’s Legislature-Approved Economic Development Incentives, has just been published. It covers a range of issues I’ve emphasized here before as well as some basic considerations reporters really need to pay more attention to.
North Carolina has some of the best economic development practices in the country, in terms of online transparency, performance requirements, use of clawbacks for non-performance by companies, sunset clauses for tax expenditures, hard caps for many tax credit programs (see my report on these points), etc. The state publishes an economic development inventory I consider to be of very high quality and consistent with international definitions of a subsidy. The most recent edition shows that in the 2008-9 fiscal year the state spent about $1.2 billion on economic development, enough to hire 24,000 people at $50,000 a year in wages and benefits.
At the same time, however, the state has persistently had problems in overvaluing potential investments and consequently offering wildly excessive subsidies for them. The best known case is Dell in 2004, when Virginia offered the company a $37 million incentive package, while the state and local bid from North Carolina came to almost $300 million on a nominal basis ($174 million present value). Other deals discussed in the report are Google ($260 million nominal value, $140 million present value), Apple ($321 million over 30 years nominal value, no present value calculation available), and a provision in a 2011 special incentives bill to allow Alex Lee Inc. to keep $2 million it should have forfeited for not keeping job promises. This last case illustrates how special legislative deals weaken the state’s performance requirements; this case will make future companies think that there may be no penalty for non-performance.
Reporters take note! This publication describes useful techniques for comparing the size of incentive packages regardless of project size or payout period of the incentive. From the European Union I borrow the term “aid intensity,” which measures the size of the incentive relative to the amount of the investment or the number of jobs created. The idea is that a $1 million incentive would be large for a call center but a rounding error for an automobile assembly plant. As a result, we need a standardized way of comparing incentives.
While in this country one can sometimes find cost per job analyzed for some subsidy packages, the EU actually uses the subsidy/investment metric as its primary measure of aid intensity. In my last post I discussed a mall redevelopment which could conceivably have an aid intensity of 96%. For comparison purposes, we should note that the highest aid intensity allowed for large firms anywhere in the European Union, is 50%, and that is only allowed in the poorest regions of the EU, mainly in eastern Europe. (Richer regions have lower allowable maxima.) A region’s maximum is cut by half for large projects over 50 million euro, and by 66% for spending over 100 million euro.
The other important concept is present value, a familiar one to accountants and economists, but not widely understood among the general public. The basic idea is simple: receiving a dollar today is worth more than receiving a dollar next year, which is worth more than receiving a dollar in two years, etc. Since incentive packages can pay out immediately (with a cash grant) or over a period of 30 or more years, we need to use present value to properly compare the size of incentives with different payout periods. This requires finding a a “discount rate” by which to reduce future payments. We then use the present value as the numerator in calculating aid intensity to be able to compare across different sizes of projects.
Using Google as an example, this $600 million project will receive $260 million over 30 years and create 210 jobs. As mentioned above, this is its nominal cost, before discounting the future dollars. Following the practice of a 1990s study by the Organization for Economic Cooperation and Development to compare subsidies among its then 23 members, I used a discount rate equal to the 10-year Treasury bond yield to come up with a present value of $140.6 million. Then the aid intensity is $140.6 million/$600 million, or 23%, and the cost per job at present value is $669,489.
We can then use these two measures of aid intensity to compare the incentive to that given for other projects and inform our judgment of whether it was a better or worse deal than other states have made, in the current context where states make such deals all the time. Of course, I believe there should be limits placed on state and local governments so we can sharply reduce net incentive spending, which has few national benefits–but that is a long time in the future.
North Carolina provides an intriguing case study because it does so much right in economic development, but it makes special deals outside its statutory incentive programs. The result is high costs and weakened bargaining position in the future. It’s a case we can learn a lot from.
crossposted with Middle Class Political Economist
Thank you Kenneth for tackling an analysis of how state/local governments might try to deal with boom or bust economies within their borders. The post at Angry Bear on what migration of population is happening and why it is happening was instructive and demonstrated there might be a variety of reasons depending on region.
It gets us beyond the simpler and inadequate election slogans of reasons for success or failure, and offers way to evaluate proposals that a voter can at least attempt to judge.
Kenneth,
The “cost” of a tax incentive is different from a direct cost. For example, a property tax exemption for a plant might be worth $X million, however, if the plant didn’t locate there, the state would not have collected this tax revenue anyway. So the true cost of the tax incentive is $0. This could account for some of the skewed numbers.
Except that the entire idea is to broaden the tax base. So to keep having entities come in that pay no taxes is getting you little. Some development may increase the property values, some may decrease. Some may have higher income for the jobs created, some may not. What good is higher income with lower property values or vice versa?
Why have the development if it is not going to contribute to the fund for paying for it’s services? I posted a review I did of RI towns and showed that the most consistant way to beat the cost of running a town was to limit development. In particular, no commercial development what so ever kept the taxes the lowest. Unless of course your town suddenly becomes popular and there is a massive population increase.
Let’s look at the Google a little differently.
$600 million/30 yrs = $20 million/yr. $20million/210 jobs = $95,238.10 income average. NC income taxes on this individual is $6803.45, family is $5253.45. Using the individual the state has off set $1,428,724.50 of that $20 million with income taxes collected.
Of course, if the state is counting on the jobs to create the tax greater than the benefit then that $20 million has to create other jobs in the economy indirectly. So:
$20million – $1,428,724.50 = $18,571,275.50 to be covered by other job creation. $18,571,275.50 / $6803.45 individual income tax paid = 2729.69 jobs needed at a taxable income of $95,238.10.
This assumes all the jobs are created immediately to cover the cost from day one. If not immediately then…
Good luck NC!
I think that the Google example, and the effort to analyse such incentivized development in general, is far too simple to allow for a full understanding fo the motivations behind a local government’s participation in such projects. The Google example refers to a $600M project with $260M in incentives, which I assume are intended to defray s portion of the $600M. Over what time period is the $600M being expended? Does that amount include the total monies being spent as a part of the project, property development. goods and services needed by the project, employee pay and benefits, etc? Most importantly, who is on the receiving end of that $600M project cost? Property is being bought or leased. From who? Insurance arrangements are being made. By whom? Janitorial supplies, secretarial supplies, machinery, etc. don’t arrive from no where. Who is on the receiving side of the $600M? Know that and you’ll know why the project is receiving government incentives far in excess of the dollar value of the jobs being created. A local development project has immediate beneficiaries. The jobs, if they come, come later. Taxes??? Don’t ask. It’s not in the business model. Government services come from the tooth fairy.
yup, my mistake. Darn eyes. Should have used the $260 million and not the $600 million.
Daniel,
I wasn’t focusing on your error which I’d regard as little more than a typo. My point is that the focus on the cost benefit analysis that we generally see offered in regards to local government development incentive projects miss the point the externality of individual benefits that accrue to the immediate participants in such projects especially in the political class in the community wherein the project takes place. Am I a cynic if I suggest that the long term good of the community is second place to the short term gains of the actors? That $600M is being spent equates to $600M is being earned, and its not mostly on new jobs.
You guys are really, really missing the forest for the trees here. It is completely irrelevant from a top-level perspective if North Carolina comes out ahead when it poaches these jobs. Yes, poaches. Steals. “Attracts”.
Yes, if NC hands Google subsidies with $140 million (NPV), and gains a revenue stream worth X in NPV, it may or not come out ahead depending on X. But you guys seem to be ignoring the obvious fact that some other state loses X revenue! From a national perspective, this is nothing but the handing of $140 million tax-payer dollars to Google. No jobs are created. Only moved across some arbitrary line. Just imagine what would happen if the feds were to ban this crap. Google would still need the workers, and would simply locate them where various logistical considerations demanded. That state would gain X revenues. In the real world scenario, Google locates to wherever offers the biggest subsidies (remember the winner’s curse in auctions, btw), real-world logistical concerns be darned. That state then gains X-$140 million, which is probably pretty close to zero. Google wins, tax payers lose, and on net, the world loses because logistics are ignored. This whole scam is a giant prisoners’ dilemma and we ought to be trying to find a way out of it rather than arguing about how quickly we should defect.
I happen to live in Japan at the moment, where this kind of crap is minimal because tax policy is set at the federal level. A 10% income tax is applied everywhere, and split 60/40 local/prefectural on a per-capita basis. When I discussed our system of state-vs-state job poaching with my Japanese colleagues, they were absolutely aghast and couldn’t figure out why the federal government doesn’t stop it. The only answer I had was “Stupid Republicans”.
Of course, the same problem exists in international affairs. Really, it is the core issue of international trade disputes. But that’s a harder problem to solve because we don’t have a world government that can force cooperation and punish defectors. In the US, however, we do. And for some unfathomable reason, we chose not to.
Chad, I can assure you we understand that tax give aways are only about the top making more.
I approached this issue with a posting back in 2008 regrading Senator Fritz Hollings. he never saw that promoting his non-union state against the union states for economic development did to the US over all what he later took on as his cause: outsourcing jobs to China.
I have mentioned that Berrie Sanders would like to pass a law stating that when a state gives up it’s local tax revenue in a bidding contest to attract business it will lose it’s fed funding. I think this would be perfect. As you mentioned, the Japan approach sounds like a win also until you butt up against the states rights argument. It’s unfortunately used as a last resort argument when all else has failed to assure acts of selfishness.
Daniel,
My point is that Kenneth may be inadvertently exaggerating the costs of the incentive by using the value of tax breaks that wouldn’t have otherwise generated the revenue anyway.
sammy,
In Investment Incentives and the Global Competition for Capital, this is what I call the myth of costlessness. If Google had not come to North Carolina, it would have gone somewhere else. It needed the facility. If states did not bid among themselves, one of them would have received the associated tax revenue. So giving the incentive really did create a cost to the state where it located, in this case NC. Moreover, if this had been a marginal investment for Google and it would not have made it without the subsidy, the investment capital would have gone to a more efficient investment. The availability of these subsidies incentivizes inefficient or inefficiently located investments that are more capital-intensive than they would be in the absence of the subsidies.
What we are actually seeing in tons of these cases is naked rent-seeking where firms have discovered they can use the location decision process as an opportunity to extract rents. In emails North Carolina was forced to release, Dell was adamant that it did not want to pay any tax. The NPV of its subsidy was 152% of the cost of its investment. In the European Union, the maximum a company can get anywhere is 50%, and that only in the poorest regions, and a region’s maximum is cut in half for investments over 50 million euro (currently about $61 million) and by 66% for the portion over 100 million euro. This is simply a ludicrous level of subsidy, and would have been so even if Dell had not closed the plant four years later.
By the way, under WTO rules, a tax break is a subsidy just as much as a cash grant.
In addition, there is an increasing trend by states to use cash grants in incentive packages, the effect of which is to increase the NPV of the subsidy compare to one paid over 10-30 years. A typical vehicle is Kansas’ STAR (Sales Tax Anticipation of Revenue) bond, which lets the state make a cash grant, using the project’s incrmental sales tax revenues to pay off the bond
Chad, a giant Prisonrers’ Dilemma, precisely. I think we need federal regulation to fix this (third-party enforcement), but the states are very adamant about giving up “their rights,” so it will be a long time coming. In the meantime, we need to be pointing out the absurd amounts of money being given away and demanding transparency in the many states where we still don’t even know what the state is giving away.
But IMO it’s not a question of “stupid Repubians.” Democrats support such incentive policies, too. In Missouri, Kansas City Democrats are one of the big roadblocks to statewide reform of tax increment financing. Around the country, there are Democratic governors doing the same thing: Granholm, Perdue, Quinn, etc.
This goes to Daniel’s point that “tax giveaways are only about the top making more.” In fact, as I mentioned to sammy, there are also efficiency costs involved with incentives, and sometimes even environmental ones. For this reason, you often find some very strange coalitions (Nader and Kasich, for example) involvd in incentive reform. Conservatives and libertarians latch onto the efficiency problems, while progressives latch on to the distributional problems.
Chad, I forgot to add that you are right about “poaches.” Even when you have a new facility, it ofen means an existing one elsewhere closes and there is no net job gain. Though there is probably some greater efficiency with a new plant replacing an old one, the gain from new jobs is way oversold if you look at it from a national rather than local standpoint.
This was true in the auto industry in North America: open a subsidized foreign plant, close a Big 3 plant. In the 1980s and early 1990s, it was literally 1:1 substitution for assembly plants.
And the problem is even worse in retail, where you probably don’t have an argument for efficiency gains. St. Louis MSA municipalities gave $2 billion in subsidies for retail but had no more retail jobs in 2007 than 1990 that couldn’t be accounted for by regional income growth, all 5400 of them.
Daniel, regardless of the tax revenue that comes from a new facility, that would have come anyway as long as the plant did. The structural situation forces state and local governments to bid for what they could otherwise (and once largely did) get for free.
In the early 1960s, incentives were positively quaint compared to today. Belvidere, Illinois, got a Chrysler assembly plant just by running a sewer line out to the plant — and Chrysler loaned the city the money to do it.
American Express built a data center in North Carolina without incentives. Most likely, it was because it knew it would soon close a call center and thus would have had new incentives clawed back. So it seems like NC has more bargaining power than it thinks if it can attract a data center without subsidies. Its low-cost electricity is hugely attractive for data centers.