Here are a few highlights:
…”Companies request abatement, not because it is necessary for their expansion, but mostly because it is offered. Others, however, frequently refuse incentives because of the “red tape” or inherent delays incurred during the expansion process” (Wallace 3).
…”The battle of securing the relocation of a major company from one area to another may be “a zero-sum game” (Campbell 376). One community cannot win without a corresponding loss to another community.”
…”Incentives are skewed to the grand slam [large company deals]; they offer little help for the smaller firms, where most new jobs are created.”
…” The trend indicates that start-up companies, especially high-tech firms, need up-front assistance, rather than tax abatement on phantom profits spread over ten years.”
…”What a subsidy does is to make it profitable for a company to locate in a less than optimal location” (Campbell 377).
…Like individual producers of goods and services, economic development entities operate as much for their self-interest and not necessarily for the benefit of the whole economy.”
…”But tax abatement zones are more effective when they define an area that “still retains a stable economic base” (Wilder 484). Perhaps this reasoning reflects the adage about not throwing good money after bad.”
…”We need to raise public awareness of an accountability problem and perhaps establish a trend for a more professional, businesslike approach in evaluating tax abatement proposals.”
Summary of Original Paper
The concept of development incentives, especially tax abatement, often can be a hotly contested topic, depending upon whom you ask. Self-interest seems to be everywhere at the center of the issue, whether it is a company looking to relocate or expand, a development employee justifying their job, or an administration attempting to expand the tax base. The running questions seem to be – Do tax abatement incentives work… and do we really need them?
What is tax abatement? Abatement means the full or partial exemption from ad valorem taxes of specified real or personal property in a designated investment zone for economic development purposes.
Rationale
It is generally assumed that the inherent basis for economic development programs and incentives is the creation of new employment and thus a reduction in poverty and public assistance. A secondary consideration is overall property tax relief: if the tax base is larger, then it is assumed to require less taxes per homeowner to support school systems funded by property taxes (Levy 206-10).
The rationale for abatement (incentives) can be very general and vague or more specific as in requiring “extraordinary investment” as the primary goal. Perhaps the best stated rationale is exemplified by Harris County, Texas, which says:
tax abatements are granted in specific target areas that may be characterized as blighted, or containing substantial numbers of substandard or deteriorating structures, inadequate sidewalks or street layout, obsolete platting or defective conditions of title. The target area should be likely to contribute to the retention or expansion of primary employment or to attract major investment in the zone that would be a benefit to the property and that would contribute to the economic development of the city. (Houston 1)
A Brief History
Government entities of all natures have employed incentives for development at an increasing rate, as if one-upmanship were the rule of the game. Those companies who know the rules and can use them well will win… Sophisticated companies, especially those that are represented by professional site selection consultants, will negotiate from a position of superior information and play the game like it is high-stakes poker (Welch 1).
Public forms of tax abatement incentives include those that are mandated “as a right” and those that are negotiated (Welch 3). Again, it is the negotiated incentives that create the greatest opportunity or cause the greatest concern-depending upon your point of view.
Incentives began to appear during the 1940s. But it was not until the proliferation of incentives since the 1980s that these offerings were tied to job creation. “The prevailing thought was that everyone would win [with incentives],” businesses, the state, and the new jobholders, assumably in depressed areas (McIntosh 1-2). The early versions of the development zones tended to be “sweeping attempts” to attract industry to less developed areas or areas with high unemployment. As communities began to prospect for larger employers, the larger firms demanded greater concessions. In 1997, “the proliferation of incentives for corporate relocation grew so intensely that the Minneapolis Federal Reserve Board officials called for congressional action to ban incentives entirely (Wallace 2).
Incentives have doubled since the 1970s and now include about two-dozen varieties. In Ohio, the basic business taxes eligible for abatement include: corporate income taxes, sales and use taxes, property taxes, and inventory or personal property taxes. Traditional incentives include tax abatements, free low-cost real estate, loan guarantees, and infrastructure improvements. But training programs are still the most popular incentives and are used by all 50 states. Tax abatements may target either specific industries or specific categories of new development, such as new construction or capital equipment purchases.
The Problem
By the early 90s, the economic incentive war between the states had become the rule. (And the same problem persists where neighboring cities vie for a new plan location.) Some experts argue that competition between states yields economic efficiency only if states limit incentives to general taxation and spending policies. “When [state] competition takes the form of preferential treatment for specific businesses… it interferes with interstate commerce and undermines the national economic union by misallocating resources -attracting and retaining a particular business is not a mitigating circumstance” (Burnstein 1). Others argue that the way cities match their incentive programs to each other, that there is no real advantage, that in achieving financial parity with incentives, it has the unintended effect of “price-fixing” and impoverishes the whole community? Communities that play the game will lose, regardless of the individual outcomes.
Community development directors argue that incentives help to level the playing field. This could be taken from two vantage points: Are we leveling the field among different community locations or between various parcels within an area? But when the playing field is full of activity, there are fewer reasons to stimulate expansion. Only by allowing businesses to locate without inducement will companies “vote” for their “desired level of public goods” and services by their choice of business location (Burnstein 2).
But, by not offering incentives, communities may well be at a competitive disadvantage with other areas. It seems that states, counties, and cities are in a great “arms race” to build an arsenal of programs and incentives that can be marshaled to secure a strategic advantage, whenever stagflation rears its head. What would happen if all development entities were unilaterally “disarmed” and had to rely on the natural advantages of their communities to attract business? I suspect it would force companies and communities to do what they do best and let others do the rest. Companies need to assess their real cost of doing business as if the grants and abatements did not exist, because they will not last forever (Wallace 3).
Most studies indicate that site selection criteria do not show financial incentives to be the major factors in business retention or expansion. Only 7% of firms considered incentives as a critical location factor. Their site considerations were primarily determined by real estate costs, site characteristics, and access, as well as their proximity to customers (Wilder 476).
Although abatement programs in Ohio are aggressive, the activity is focused on infrastructure improvements that will benefit more than the target firm. Officials maintain that Ohio incentives are not used as “bait” to lure companies across state lines, but to ensure that the company will succeed. Ohio has also made a conscious effort to attract more high-tech industries by “selling the natural reasons why companies would want to locate here” apart from financial inducements (Emerson 1-5).
The general trend indicates a curbing of the appetite for tax abatement. One consulting firm indicates that about 80% of communities surveyed show a decrease in available incentives (Stackhouse 2). But, some states, such as Michigan and Pennsylvania, still promote some “tax-free zones” that boast a comprehensive abatement package approaching 100% of all business taxes for up to 12 years. Yet many communities find these incentives less necessary, but wonder how they can “put the incentive genie back into the bottle” (Stackhouse 2).
Development entities are focusing more and more on the retention of companies rather than the poaching of businesses from other areas. However, an economist might remind us that some firms need to move anyway to achieve greater efficiency. Inducing them to stay does not solve their operational or locational problem, but merely ameliorates their symptoms-perhaps prolonging the inevitable…plant closure.
(If you would like to read the complete paper, contact JamesMaxfield@MaxfieldRealEstateGroup.com to receive a copy by email.)
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