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Corporate “inversions” shift the tax burden to us

Corporate “inversions” are back in the news again, as multinational corporations try every “creative” way they can to get out of paying their fair share of taxes for being located in the United States. With inversions, the idea is to pretend to be a foreign company even though it is physically located and the majority of its shareholders are in the U.S.

“What’s that?” you say. At its base, what happens with an inversion is that a U.S. corporation claims that its head office is really in Ireland, the Cayman Islands, Jersey, etc. Originally, all you had to do was say that your headquarters was abroad. Literally.

Now, the rules require you to have at least 20% foreign ownership to make this claim, but companies as diverse as Pfizer, AbbVie, and Walgreen’s are set to run rings around this low hurdle. The basic idea is that you take over a smaller foreign company and pay for it partly with your own company’s stock to give the shareholders of the foreign takeover target at least a 20% ownership stake in your company.

Thus, with pharmaceutical company AbbVie’s takeover of the Irish company Shire (legally incorporated in the even worse tax haven Jersey), Shire’s shareholders will own about 25% of the new company, thereby qualifying to take advantage of the inversion rules. It expects that its effective tax rate will decline from 22.6% in 2013 to 13% in 2016. Yet nothing will actually change in the new company: it will still be headquartered in Chicago, and the overwhelming majority of shareholders will be American.

As David Cay Johnston points out, even some staunch business advocates like Fortune magazine are calling this tax dodge “positively un-American.” Further, as he notes, Walgreen’s wants to still benefit from filling Medicare and Medicaid prescriptions even if it ceases to pay much in U.S. corporate income tax. In other words, it will get all the benefits of being in the U.S., including lucrative government contracts, without paying for the costs of government.

As I told The Fiscal Times, if companies like these get their tax burden reduced, there are only three possible reactions that can occur: someone else (i.e., you and me) will pay more taxes; the government must run a higher deficit; or government programs must be cut. Of course, there is a limitless number of combinations of these three changes that can result, but one or more of them has to happen.

What can we do about this? One obvious answer to to raise the bar for foreign ownership to at least 50%+ to call a company foreign. Even more comprehensive, as reported by Citizens for Tax Justice, would be to continue to consider a company “American” for tax purposes as long as it had “substantial operations” in the United States and was managed from the United States. Furthermore, the Obama Administration has proposed limiting the amount of deductions American companies can take for interest paid on loans “from” their foreign subsidiaries, thereby preventing what is often called “profit stripping.” Another idea, from Senator Bernie Sanders, would be to bar such companies from government contracts.

The whole concept of “inversions” no doubt sounds very arcane to the average person. But one of the bills to rein them in is estimated to raise $20 billion in tax revenue over the next 10 years. The stakes are substantial, so we need to take a minute to wrap our head around it if we want to head off yet another way in which the tax burden is shifted to the middle class.

Cross-posted from Middle Class Political Economist.

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Piketty on the minimum wage

A lot going on with the minimum wage lately, but I will contextualize it first with Thomas Piketty’s analysis in Capital in the Twenty-First Century, pp. 308-313. It’s important to remember that one of the keys to the book’s success is that it is built on a gigantic trove of long-term data. His French wealth data, for example, goes all the way back to the immediate aftermath of the French Revolution!

Piketty writes in this section about increasing labor income inequality in the United States and the importance of labor market institutions in affecting wages in the medium term even as education (though see Jeff Faux’s dissent in The Servant Economy) and technology are the keys to the long-run wage possibilities. He counterposes the steady increase in the real (i.e., inflation-adjusted) value of the French minimum wage since 1950 to the decline of the real U.S. minimum wage since it peaked in 1969 at $10.10 in 2013 dollars. At $7.25 today, it is a full 28% below its peak, and 1/3 less than the current French minimum wage at purchasing power parity in 2013 (see stats.oecd.org, search “data by theme” and select “labour,” then “earnings,” then “real minimum wages,” and set the series to “US$PPP” and the pay period to “hourly.”)

This decline of the real value of the minimum wage is why Piketty argues that an increase in the U.S. would make sense, much more so than in France. At this low level, there is much less danger of a negative impact on the number of jobs. His key insight is that if wages are too low, that itself causes economic inefficiencies and can even create inefficiencies for the firm. In particular, if wages are too low, it can cause workers to acquire fewer firm-specific skills than would be optimal for the employer. This would seem to hold economy-wide as well: if the general wage level is too low, workers have less incentive to acquire skills that would make them and the economy as a whole more productive. Additionally, Piketty argues that employers’ superior bargaining position and the absence of “pure and perfect” competition in labor markets justifies the limits on companies’ power embodied in the minimum wage.

The minimum wage has also been in the news this month. The biggest story is that for the first time Germany has adopted a minimum wage effective in 2015, set at €8.50 ($11.60) an hour. This was the price Angela Merkel had to pay to bring the Social Democratic Party into her governing coalition. In addition, the minimum wage in the future will be set by a national commission made up of labor and business representatives.

Finally, a new study by the Center for Economic Policy Research finds that the 13 states that raised their minimum wage on January 1 had higher rates of job growth (0.99% vs. 0.68%) through May 31 than the 37 states that did not raise their minimum wage. While the study does not claim to be definitive, it is one further piece of evidence that the minimum wage is not a job killer at the levels seen currently in the United States.

Cross-posted at Middle Class Political Economist.

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Stopping Job Piracy in Dayton, Denver,… and maybe even Kansas City

As I have reported before, job piracy is a big problem in metropolitan areas like New York City and Kansas City. Giving subsidies to relocate existing facilities is a net loss for the country and for the region as well. The flip side is that the existence of job piracy makes it possible for companies to threaten to leave their current location unless they get a subsidy, as Sears has done twice in Illinois. I showed in my book Competing for Capital that several multi-state agreements to end job piracy have been total failures.

A new study by Good Jobs First, “Ending Job Piracy, Building Regional Prosperity,” reports on a couple of success stories. Notably, these have not involved state governments, but take place in two metropolitan areas, in Dayton, Ohio, and in Denver. The study also reports on failed regional efforts in Minneapolis/St. Paul and Kansas City (but see more below).

The oldest of these successes is the Metro Denver Economic Development Corporation, created in the late 1980s. Its aim is to promote the entire metropolitan area as a single region, using transparency and information exchange among municipalities to prevent site selection consultants from playing different cities off against one another. All members sign a Code of Ethics committing themselves to these goals.

The Code is not a law, but it does provide for a dispute resolution process in the case of an alleged violation. A complaint triggers this process:

the Chair of the organization will call together three to five members into a meeting with the offender. If the member’s behavior is determined to be inappropriate, the offending individual is asked to issue a public apology or issue a statement to staff correcting their action and guiding future actions.

As the Good Jobs First report points out, dispute resolution has only been invoked three times in the 26 years the agreement has been in effect, and no Economic Development Corporation member has had to be expelled, the strongest sanction available for violating the Code of Ethics.

In Dayton/Montgomery County, Ohio, there are two programs that promote regional cooperation. Economic Development/Government Equity (ED/GE) began in 1991, and provides a $5 million annual pool for “regionally significant projects in the county.” It also shares increased tax revenues with slower-growing municipalities in the county. Applications for the $5 million fund are judged competitively and the process will only consider funding for relocations under very narrow circumstances and only then with a letter of support from the city losing the company.

In addition, all the Montgomery county municipalities, as well as some in neighboring counties, participate in a program called Business First! that promotes the region as a whole and, like Denver’s Code of Ethics, requires information sharing when a company is seeking to move within the region. Business First! also provides for a transitional tax-sharing agreement when there is an intra-regional move.

The new report emphasizes the need for engagement with economic development officials, because they actually do the work and they represent the institutional memory necessary for these agreements to remain viable in the long term. As always, transparency is a key element that is a precondition for accountable governance.

In addition to these success stories, potential good news on the job piracy front came out of Missouri last week. On July 1, Democratic Governor Jay Nixon signed a bill passed by the Republican-majority legislature that would disallow the use of state incentives to firms relocating from four Kansas counties to the four counties that make up the core of Kansas City, Missouri. This represents a dramatic turnaround from 18 months ago, when both Nixon and Kansas Republican Governor Sam Brownback told New York Times reporter Louise Story, on camera, that they would continue poaching from the other state.

Missouri’s law takes effect only if Kansas passes a parallel law. As Kansas City business leaders have pointed out, the two states have given more than $200 million in tax breaks for relocations, only to see a net 400 jobs move to Kansas. Unfortunately, so far Kansas leaders have given no indication that they will follow suit. However, the Missouri law gives Kansas until August 28, 2016 to do so. Hopefully, some sense will prevail in Kansas by then.

Cross-posted at Middle Class Political Economist.

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Think Obamacare’s not working? Think again

Republicans seem obsessed with the idea that Obamacare is a failure; that it is a “train wreck” exacerbating unemployment. But is that really so?

First of all, the claim that the Affordable Care Act is a job killer flies in the face of reality, as Dan Diamond at Forbes reports:  Since the law was signed in March 2010, the economy has added 7.7 million jobs, 982,300 of which are in the healthcare field. If Obamacare is a drag on employment, its effect is being drowned by other factors. Of course, the fact that healthcare is gaining jobs at a healthy clip suggests it’s not a drag on employment at all.

Diamond also highlights important differences between states that expanded Medicaid and those which did not. He cites a Colorado Hospital Association study of 465 hospitals in 15 expansion states and 15 non-expansion states, which show sharply divergent patterns in the two groups on the number of people seen at the hospital without insurance, and the volume of charity care per hospital. Here is his chart, a selection from that available in the CHA study.

 

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Source: Colorado Hospital Association, June 2014, link above

 

As we can see, hospitals in both expansion and non-expansion states were seeing between 4.5% and 5% uninsured quite consistently in 2012 and 2013. (Note that the study did not include Texas or California, the biggest state in each category, both of which had high overall uninsured rates.) In the first quarter of 2014, as new insurance began to kick in, there was an immediate drop to 3.1% in the expansion states, while the figure actually edged up in the non-expansion states to 5.0% from 4.8% a year previously.

For charity care, there was already a noticeable difference between the two sets of states over 2012-2013, where hospitals in expansion states provided an average of $3 million in charity care per quarter vs. about $4 million in non-expansion states. Again, we see an immediate improvement in the expansion states in the first quarter of 2014, falling by about 1/3 to $1.9 million, compared to a slight increase in the non-expansion states relative to the first quarter of 2013.

Meanwhile, rural hospitals are closing in non-expansion states, prompting the Republican mayor of Belhaven, North Carolina, where Vidant Pungo Hospital is closing, to call on the state to accept the Medicaid expansion made optional by the U.S. Supreme Court’s ruling that upheld the ACA’s individual mandate.

In another post, Diamond underlines other dimensions of Obamacare that usually go under the radar. Perhaps the most powerful, but rarely discussed, effect is that on healthcare quality. Diamond catches a December 2013 study from the Centers for Medicare and Medicaid Services (CMS). As Diamond explains, one early ACA initiative allowed CMS to reduce Medicare payments to hospitals that had high re-admission rates, which is generally an indicator of poor care. Specifically, as the study says, re-admissions within 30 days “often means there have been unclear instructions to patients or lack of follow-up care.” Here is the 30-day re-admission rate for Medicare from 2007 through August 2013.

 

Line chart. Shows annual readmission rates holding steady at 19 percent from 2007-2011, then declining to 18.5 percent in 2012 and 18 percent for the first 8 months of 2013.

 

Source: Office of Information Products and Data Analytics, CMS (link above)

 

As we can see, there was virtually no change from 2007 through 2011. But in 2012, the rate fell by a full half-point, and by even more than that in the first eight months of 2013. As Diamond points out, this is pretty hard to spin as anything but a success for Obamacare. He also provides a map from the study which shows that virtually the entire country had an improvement (see link to the study or his article). In only six states were there any areas seeing worse performance, defined as an increase of over 0.25 percentage points. Numerous states saw increases in all of their CMS regions, and plenty of regions saw improvements greater than 1.5 percentage points, including Las Vegas, Memphis, and almost all of Kansas.

Finally, let’s look at the issue that has dominated the discussion: Are more people actually insured? Paul Krugman sends us to the Gallup poll on the percentage of uninsured Americans. The poll, based on more than 30,000 interviews in April and May, showed that the uninsured rate dropped 3.7 percentage points for all adults from the 4th quarter of 2013 to April-May 2014 (see graph below). It dropped 6.2 percentage points for African-Americans and 6.0 points for those with an income below $36,000.

 

Percentage Uninsured in the U.S., by Quarter

 

The best estimate of total ACA enrollments continues to come from Charles Gaba at ACAsignups.net, who estimates a range from 23.6 to 28.2 million gross enrollments.

Finally, don’t forget the PP in PPACA, patient protection. Everyone can now get insurance regardless of pre-existing conditions, no one can have their insurance canceled because they get sick, and no one has annual or lifetime insurance caps anymore. Indeed, these factors may well lead us to see a decrease in the country’s bankruptcy rate, as medical bankruptcies become less frequent.

Obamacare not working? Don’t believe the hype.

Cross-posted at Middle Class Political Economist.

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Apple, Starbucks, Others Under EU Tax Investigation

No sooner do I comment on the difference between tax planning and tax avoidance than Richard Murphy points out that several multinational corporations are having their tax deals looked at for potential violations of the European Union’s state aid rules. As The Guardian and The Wall Street Journal report, there are three cases currently under investigation by the European Commission, but more investigations may be opened in the near future.

First is Apple in Ireland. What a surprise! It has a subsidiary it claims is taxable nowhere, incorporated in Ireland but managed from California, which under Irish law makes the subsidiary not subject to Irish tax. Of course, since it is incorporated in Ireland, Apple can defer its U.S. taxation on the unit’s profits until it repatriates them, if it ever does so. Two issues are relevant here: Did Ireland’s creation of this class of entity provide firms with state fiscal aid? Second, did Ireland negotiate a special deal with Apple giving the company a tax rate far below Ireland’s already low 12.5% corporate income tax rate, as Apple CEO Tim Cook testified last year before the U.S. Senate, under oath. In fact, according to the New York Times, the company paid ” as little as one-twentieth of 1 percent in taxes on billions of dollars in income.” One source quoted by the Times said the company saved $7.7 billion in taxes in 2011.

If the tax saving in Ireland is deemed to be state aid, the Commission would have to determine two things: Was it notified to the Commission, as required by the state aid rules? (No, or we wouldn’t be having this investigation in the first place.) Is the aid compatible with the common market, and thus allowable? My guess is that the Commission expects to find that fiscal aid to Apple and others (see below) distorts competition, and hence is not compatible with the common market.

It is worth remembering that Ireland has a 12.5% corporate income tax rate, rather than the 10% rate it had for decades, precisely because in 1998 the Commission found that the 10% rate was state aid and was not compatible with the common market (Competing for Capital, p. 95). So the use of the state aid rules to attack arcane tax provisions is nothing new for the Commission.

The second case is Starbucks and possible fiscal aid from the Netherlands. I have already reported on how the company happily tells investors how profitable its British subsidiary is, but books a loss in the United Kingdom and had no tax liability for 14 years. As discussed then, the issue ultimately revolves around transfer pricing between the “loss-making” U.K. affiliate and the Dutch subsidiary which holds Starbucks’ intellectual property and collects 6% of revenue as royalties, plus transfer pricing into Switzerland. Theoretically, the case could also expand to the Swiss transfer pricing as Switzerland is also subject to state aid rules as part of its free trade agreement with the European Union.

Finally, the Commission is investigating whether Fiat receive state aid from Luxembourg, again as part of its tax treatment there.

All three of these cases demonstrate what I emphasized in my last post, namely that tax avoidance increases tax risk, whereas tax planning does not. It also underscores a point I made in Competing for Capital that the Commission can be quite creative in finding ways to attack fiscal provisions under the state aid rules. It’s good to see that the Commission is actively attacking corporate tax avoidance; it would be great to see equal creativity and perseverance on this side of the Atlantic.

Cross-posted from Middle Class Political Economist.

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Tax planning or tax avoidance? One simple test

Over at Tax Research UK, Richard Murphy offers a simple test to distinguish between tax planning and tax avoidance. As he told a journalist, “That is easy. It’s getting legal opinion.”

With tax planning, Murphy says, you decrease your tax risk. “There are obvious examples: paying money into a pension, for example, does not create tax risk, and nor does putting money into an ISA [a UK individual savings account, which is similar to an IRA but more flexible] within allowed limits.”

By contrast, “Tax avoidance, on the other hand always, and without exception, increases your tax risk.” He gives examples of questionable allowances or use of tax haven structures. “In all such cases, the taxpayer’s risk is increased by undertaking the transaction. That is what tax avoidance involves.”

Murphy sends us further to David Quentin‘s tax blog. Here Quentin points out that there can be effective or ineffective tax avoidance, but that there is no such thing as ineffective tax planning. This, he argues, is an embarrassment for tax avoidance defenders, inasmuch as effective tax avoidance and ineffective tax avoidance are the same activity. With tax planning, there is no question that what you’re doing is legal. With tax avoidance, there is precisely such a question. So, as Murphy said, tax avoidance involves risk. Therefore, your tax adviser will suggest you get a legal opinion to “validate” the legality of what you are doing. While a putative tax avoider will use this opinion in arguing with tax authorities, it is ultimately the latter (and the courts) that will decide on the legality of the action taken.

What do you think? Is the distinction between tax planning and tax avoidance as easy to make as Murphy claims?

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Another day, another bad incentive deal

No sooner had I finished my mini-series on evaluating proposed location subsidies then @varnergreg sends me this story about a new copper tubing manufacturing facility opening in one of the nation’s poorest counties, Wilcox County, Alabama. This is clearly the sort of place where I think we should consider using investment incentives, but the sheer size of the subsidy relative to the investment (known as “aid intensity”) makes this just another bad deal. Indeed, the subsidy to Golden Dragon Copper is potentially worse than Electrolux in Memphis, where state and local governments essentially gave the company a free plant.

The package includes:

$20 million in state economic development discretionary incentives; $8.5 million in property tax abatements; $5.1 million in sales and use tax abatements; $5.7 million for an industrial road and bridge to support the plant; $1.8 million in worker training services; and site purchase, prep and water and sewer improvements worth about $1 million.

But those are just the small bits. Do you have your calculator out? That comes to $42.1 million so far, a little less on a present value basis because the property tax abatement will be paid over time (unspecified how long in the article).

The biggest part of the subsidy is comprised of “capital income credits worth up to $160 million over 20 years.” But, as reporter Dawn Kent Azok goes on to note, “Generally, companies don’t realize the full amount because they are tied to income tax liability.” Fair enough, but that leaves us with a lot of uncertainty in analyzing the subsidy. If we start at the midpoint and call it $80 million, here is what we come up with.

Obviously it’s not a retail project, we know who the investor is, and it is a new facility. However, as countrycat points out, there is an existing copper tubing manufacturer in Alabama, Wolverine. Therefore, the subsidized increase in supply is a definite threat to create unemployment elsewhere in the same state.

For creating our main cost metrics, we’ll note that the plant will have 300 workers at full capacity, and the investment is $100 million. You can see where this is a problem: using the $80 million midpoint, we are talking about $122.1 million in subsidies, which comes to $407,000 per job and 122.1% of the investment. Are these large figures? As we can see by consulting the Megadeals database, and as I have discussed more concretely regarding Electrolux (link above), these are extremely large figures. An automobile assembly plant will cost about $150,000 per job with an aid intensity of about 33%. So Golden Dragon will get more than 2 1/2 times as much per job, and 4 times the aid intensity of an auto assembly plant, without requiring the extensive supplier network you’d see with the auto plant.

Moreover, it doesn’t pay as well as an auto plant, starting at $15 per hour. No information was given on benefits, so we can’t evaluate the project on that basis. There was also no information given on whether the project will benefit from eminent domain.

As noted above, Wilcox County is one of the poorest in the country. This is clearly the biggest positive aspect of the project. It is more than an hour away from Montgomery, according to Google Maps, so we are not contributing to sprawl and there is no public transportation system to link the plant to. I have no information on the company’s track record or whether it would have invested without the subsidy (have I mentioned information asymmetries lately?) I don’t know enough about Alabama to know how well it enforces subsidy agreements or what the government’s opportunity cost might be, but in any event I don’t consider them necessary to know to see that this is a bad deal.

The two factors I think are most important here are that it is located in a very poor area, but more decisive is the huge cost, whether measured per job ($407,000 vs. $158,500 for Airbus in Alabama) or relative to the investment. The poorest regions of Europe (think Bulgaria, with 2012 GDP per capita of $6977, vs. $10,903 for Wilcox County) cannot give more than 50% of the cost of the investment (2014 regional aid guidelines, point 172), and for an investment this large that maximum would be reduced by 50% for the amount over about $67.5 million (50 million euros; see point 20 (c) of the guidelines), so 122% (and potentially more) is simply off the charts.

What the Golden Dragon case highlights is that companies know how to extract rents from their location decisions, and that desperation is not conducive to getting a good bargain.

Note: This is one of the situations where conversion of other currencies should not use purchasing power parity adjustment, so Bulgaria’s per capita income is expressed in current U.S. dollars. The reason for this is that if a company were choosing between investing in the United States or Bulgaria, it would have to pay the actual wage rates prevailing in the two countries, not wages adjusted for purchasing power.

Cross-posted at Middle Class Political Economist.

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Is that a good economic development deal? A checklist

In my last post, I discussed one of the most important sets of questions regarding any proposed economic development subsidy: How much does it cost? Is that too much? The answer, assuming that we are not going to overhaul our broken subsidy system overnight, was that we see if we’re paying too much by looking at what other states and cities have paid for similar projects.

This presumes, of course, that we know how much the incentive package costs in the first place. There are, unfortunately, far too many cases where total incentives were far higher than what was originally announced to the press. Two noteworthy examples are Nissan in Mississippi and Electrolux in Tennessee. It may take sustained political effort just to keep politicians and economic development officials from trying to pass off this kind of balderdash.

Once we know the cost, we need to ask questions about the benefits of the project and the administration of the project by the relevant government(s). Without further ado, let’s jump right in:

1) Is this a new project, or is the subsidy simply being given to move an existing facility from one location to another? If this is a relocation subsidy, just say no. It does the country no good to give subsidies to create no new jobs. Many times, such moves take place within a single metropolitan area (Kansas City, for example). One state’s temporary gain creates an incentive for later retaliation. The Job Creation Shell Game has many more examples of these outrages, and points out that states already know how to write legislative language to prevent within-state relocations from being subsidized.

However, just because a project doesn’t directly move an existing facility, that doesn’t mean the jobs created will all be net new jobs for the national economy; indeed, they may displace existing jobs in the same state or same city. The automobile industry in the U.S. and Canada has shown this dynamic for decades, and the St. Louis retail study mentioned below provides another well-documented example.

2) Is this a retail project? This, too, is an automatic disqualifier. As Greg LeRoy of Good Jobs First like to say, retail is not economic development; it’s what happens after you have economic development. Egregious cases like the wealthy St. Louis suburb of Des Peres (median household income of $90,000 in 1990), which in 1997 gave a $29 million subsidy to a local mall to attract a Nordstrom’s, are legendary. But in the most comprehensive regional study of its kind, the East-West Gateway Council of Governments, the regional planning organization for metropolitan St. Louis, documented that from 1990 to 2007, local governments gave $2 billion in subsidies to retail. In that time period, retail employment grew by only 5400, which can probably be fully explained by income growth in the metropolitan area. In any event, these jobs vanished with the Great Recession.

Possible exception: Good Jobs First lists one possible exception: “Except in the rare instance where there is a true dearth (a low-income neighborhood without a grocery store, for instance), retail should be built without taxpayer aid.” Amen to that.

3) How many jobs will be created? This is obviously the most common justification for incentives that government officials give. Once we know how many jobs are supposed to be created, we can calculate cost per job, an important comparison metric. It also gives us a clear benchmark to see if the proposed investor is living up to its commitments. But beware: Job numbers can be manipulated. Not only is indirect displacement possible, but the rosy numbers the company, consultants, and government throw around can be misleading. Only be concerned with what the company will be held responsible for, which almost(?) always means direct jobs. Consultants will bandy about model-based predictions of “indirect” and “induced” jobs, but if a company’s subsidy won’t be cancelled or cut for failure to meet those predictions, don’t get distracted by them.

4) What are the pay and benefits for this job? The higher the better, obviously, and one more reason that retail should almost never be subsidized, since its job quality is usually substandard. Worker training is another positive characteristic an economic development can provide.

5) Does the project require the use of eminent domain? This is usually a disguised subsidy, since the possibility of a court deciding the value of a person’s property gives the buyer more leverage in negotiating with property owners. Not to mention that the trauma of forced relocations is a highly disturbing one.

6) Does the area that will host the project have objective evidence of economic deprivation, such as high unemployment or low per-capita income? If not, the subsidy probably isn’t needed, and just raises the subsidies that genuinely deprived areas will have to pay to land investments.

7) What is the track record of the company involved? Is it known for bad labor, environmental, or other practices? Demerits for problems here.

7a) Is the company’s identity hidden by a site location consultant? It’s worth saying “no” to this pernicious practice. Information asymmetries are bad enough already in the site location process without having taxpayers being deprived any way to evaluate the company involved.

8) What taxpayer protections are built in? Does the city or state have strong requirements on job quality and other best practices, and will it enforce them through clawbacks of the subsidies (requiring repayment) if necessary? This should be second nature to states, but in the past few years, Tennessee has negotiated at least three megadeals (Electrolux, Wacker Chemie, and Hemlock Semiconductor) that specifically excluded clawbacks from the agreement, even though clawbacks are on the books in Tennessee.

9) Would the investment go forward even without the subsidy? If so, obviously you don’t want to give the subsidy. In practice, of course, you’ll never really know. Did I mention information asymmetries?

10) Does the project connect to the public transportation grid? Alternatively, is it contributing to urban sprawl?

11) What is the opportunity cost to government? The total amount of state and local subsidies is more than enough to hire every public-sector worker laid off since the beginning of the Great Recession. Could the money going to the subsidy be better spent on education, health, or infrastructure?

To summarize: Just say no to subsidized relocations, subsidies to retail, anonymous investors, and subsidies in rich locations. Calculate the cost per job and aid intensity of the proposed project and compare them with those of similar projects. Then comes the more difficult task of estimating the benefits of the project (jobs, training, wages, etc.), where it is necessary to carefully examine claims made by proponents, which will always err on the side of overpromising. Dig into the proposed investor’s track record. Companies rarely change their spots, with British Petroleum being a egregious example. And always ask if the money could get more economic development bang for the buck if spent on things like infrastructure, education, and health.

Good luck!

By the way, if you’ve got disagreements or suggestions, I’d love to hear them.

UPDATE: Phil Mattera of Good Jobs First let me know that I missed points 6, 9, and 10 in my original post. I can only plead temporary insanity.

Cross-posted at Middle Class Political Economist.

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Getting past economic development subsidy hype

It’s a familiar situation: business and government officials are promoting a new economic development deal which naturally includes subsidies for the investor. They may be touting a consultant’s study touting massive ripple effects and fantastic taxpayer return on investment. Should you believe them?

Of course not. Consultants, whether they technically are working for the company or the government, don’t get paid to say deals don’t make sense. Or at least they don’t if they want future contracts with the company or city/state/province/country paying them.

What’s a taxpayer to do? First, you need to know that uncontrolled subsidy competition like we have here in the United States is going to systematically provide higher subsidies than will a rules-based system like that of the European Union. The EU’s state aid rules guarantee transparency, restrict location subsidies to the poorest regions, and cap the amount of subsidy a project can receive based on two principles: 1) The richer the region, the lower the maximum subsidy allowed (with 0 as the maximum in many regions); and 2) For large projects, the maximum subsidy is reduced below the region’s normal percentage cap (determined under the first principle) with a 50% cut in the cap for projects over 50 million euros and a 66% cut for the subsidy on the amount invested over 100 million euros. So you need to remind elected officials and economic developers of the need for transparency and real limits on subsidy use.

Realistically, though, we are a long way away politically from having rules like the EU’s. Right now, we’re making progress on transparency but not so much on substantive rules, not even anti-piracy agreements. What do we do to evaluate investment incentives now?

The goal in bargaining is to get the most benefits for the least cost. How do we know if the cost is high or low? This is where the Good Jobs First Megadeals database comes in. We can use it to compare the cost with similar deals made elsewhere in the United States. You can use Subsidy Tracker if you want to look at smaller deals, but for my purposes in this post I can’t deal with a quarter of a million projects, so I am sticking with Megadeals.

Projects vary widely in size, so to compare different subsidies we need metrics, or standardized ways of measuring them. Knowing the gross cost  of a subsidy is not enough (and technically, using the present value of the subsidy rather than its gross cost would be better, but would not solve this problem). As I wrote in a report for the North Carolina Budget and Tax Center, $1 million would be a large subsidy for a call center, which needs little more than computers and phone lines. But $1 million would be miniscule for an automobile assembly plant, which can cost as much as $1 billion to build.

The good news is that we don’t have to reinvent the wheel to obtain these metrics. Two good ones already exist, cost per job (subsidy divided by the number of jobs) and what the European Union call “aid intensity” (subsidy as a percentage of investment). The EU’s rules set limits as discussed above in terms of aid intensity, but using both metrics together is even more illuminating.

Better news still is that the Megadeals database already contains the data needed to calculate both cost per job and aid intensity. Since you can download Megadeals in spreadsheet form at the link above, I did just that and then added two columns (cost per job and aid intensity) to create a spreadsheet with these metrics. Based on an informal conversation we had in March, Christopher Lau, a Senior Advisor in the Ontario Ministry of  Economic Development Trade and Employment, in an effort outside of his official capacity, added a chart grouping all the automotive investments together. This is on the larger of the two spreadsheets at the link below:

https://sites.google.com/site/middleclasspoliticaleconomist/megadeals-with-metrics

Christopher’s chart (see below) lists all the projects from largest to smallest aid intensity, so it’s a good place to begin to see the range for an auto plant. We can see from the list that the aid intensities are pretty tightly bunched from 15% to 41%, with no gap greater than 4 percentage points within that range. We can presume that anything above 41% is overpriced, especially the Gestamp project, since a stamping plant is one of parts facilities you would hope to have locate near an assembly plant, which means you would normally subsidize it less than an assembly plant.

Even  within the 15-41% range, we shouldn’t conclude all are reasonably priced given the situation states and cities are currently caught in. We would want to factor in when the facility was built, focusing on the most recent experience when discussing a potential new project. We would want to know the location, the size of the project and the number of jobs created. And we need to remember with regard to jobs that if we build a new assembly plant, its output will reduce the sales and jobs at existing facilities, so the country’s net job gain will be much less than the total employment at the new plant.

This post illustrates how we can use the Megadeals database to help evaluate the cost of a proposed subsidy deal. In my next post, I want to reiterate all the best practices that should be attached to any deal before we can say that it is a relatively good one under the United States’ current Wild West subsidy system.

 

 

For image, please see: http://www.middleclasspoliticaleconomist.com/2014/05/basics-is-that-good-economic.html
Source: Calculated from the Good Jobs First Megadeals spreadsheet.

Note: Christopher Lau’s analysis in this article is his own and does necessarily reflect the views and opinions of the Ministry in which he is employed.

 

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Everything you need to know about Tax Freedom Day®

Monday, April 21, was 2014 Tax Freedom Day®, according to the Tax Foundation. The Tax Foundation is not exactly known for unbiased research, and its promotion of Tax Freedom Day® is no exception.

The Foundation claims that Tax Freedom Day® is “a vivid, calendar-based illustration of the cost of government.” In other words, instead of saying that its analysts expect total taxes in the United States (including social insurance) to reach 30.2% of net national income (NNI) in 2014, they say that Tax Freedom Day® arrives three days later than last year. Precise, huh?

Of course, the word “freedom” tips us off to the fact that the Tax Foundation is actually trying to create an emotional response. Something along the lines of, “Oh boy, after today I’m working for myself rather than the greedy government!” The implication further is that the later Tax Freedom Day® occurs, the worse it is for the country. The thing is, neither of these insinuations is true.

As the Center on Budget and Policy Priorities points out every year, that emotional response, frequently picked up directly by the media, is not true for the vast majority of Americans. As CBPP’s Figure 1 below shows, for the federal portion of taxes, more than 80% of Americans are paying less than the 20.1% federal component of Tax Freedom Day® would suggest. (In addition, the burden of some taxes does not fall on individuals at all.) The Tax Foundation responds that it’s not trying to mislead anyone, it’s just comparing “total U.S. tax collections with total U.S. income.” Of course, if that were all it was really trying to do, it could just say that projected tax collections equal x% of NNI. But no, it trumpets Tax Freedom Day®.

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