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March 17, 2016
Downsides Inherent in Tax Incentive Deals Drawing Greater Scrutiny
by Paul Jones

Full Text Published by Tax Analysts®

Multibillion-dollar tax incentive deals are often portrayed as a win-win situation: A state or locality is promised thousands of jobs, and a company picks up lucrative tax breaks to offset expansion or relocation.

However, those deals are not without drawbacks for businesses.

An $8.7 billion extension of tax credits Boeing Co. received in Washington state in 2013 was sold to taxpayers as a revenue-generating deal that could create 8,500 jobs in the state, while a $1.3 billion tax break approved by Nevada in 2014 for electric car giant Tesla Motors Inc.'s $5 billion "gigafactory" came after the company shopped for deals in multiple states. Both companies are now being criticized by skeptical legislators, unions, the media, and others -- Boeing for its recent job cuts and Tesla for its project completion timeline and hiring targets.

The scrutiny of incentives extends to other megadeals as well, including public financing of sports stadiums and tax breaks for amusement parks.

High-profile deals had "better meet all of these lofty aspirations that the legislature dreamed up, the company promised, and the citizens sometimes just assumed," incentive package negotiator Brent Pollina of Pollina Corporate Real Estate told Tax Analysts.

Meanwhile, states offering major deals take big risks, including lost revenue and failed projects. Defenders argue that incentives are a useful tool for growing and diversifying local economies, but some experts argue that big incentive packages often prove more troublesome than they're worth.

Manufacturing Deals Draw Scrutiny

Perhaps one of the biggest incentive packages to recently draw criticism is the 2013 Boeing deal, which extended from 2024 to 2040 existing tax breaks targeted at the aircraft manufacturer. Boeing has cut thousands of jobs in Washington since then, prompting outrage from lawmakers and unions.

"Everyone believed that jobs would increase in the state," Washington Rep. June Robinson (D) said.

According to Robinson, lawmakers did not include language specifying workforce levels at Boeing's request. She has since pushed several bills that would tie tax breaks and credits to in-state employment requirements.

Boeing argues that it has honored the agreement to base its 777X airline assembly in Washington state, with spokesman Paul Bergman noting that the company has invested over $1 billion in a new wing factory in Everett. Supporters note that Boeing's job growth numbers were long-term figures and that the company's expansion will boost other aerospace companies.

Kriss Sjoblom with the Washington Research Council said the deal will ultimately benefit the state. According to Sjoblom, the company's employment grew after the original credits were approved in 2003.

But the controversy shows how the perception of a deal can quickly change. "These high-profile things can get more money," but they also draw more backlash, according to Pollina.

On the other hand, the deal does provide some protection to Boeing.

"The state can talk, make speeches in the Legislature," but Boeing can sue if Washington tries to break the arrangement, Pollina said.

Kenneth Thomas, an investment expert at the University of Missouri-St. Louis, said the Boeing case is an example of how negotiations between major companies and governments are often skewed toward the companies.

"There's information asymmetry," Thomas said. "The company can move, [but] the state doesn't know how much or how willing the company is to move. It puts Washington in a bad bargaining position."

Thomas said he thinks the Boeing deal cost the state more than it should have. "This is definitely the largest subsidy package in history in terms of cost per job," he added.

A 20-year, $1.3 billion deal between Nevada and Tesla to build a massive gigafactory battery plant near Sparks has also produced some controversy. The arrangement initially drew attention for its large size, but more recently the media has scrutinized the deal over reports indicating that the factory is behind schedule.

"They said they were going to have Phase 1 and 2 [of Tesla's plant] completed and would be starting on Phase 3 [at this point], but they've only completed Phase 1," said Michael Schaus, spokesman for the Nevada Policy Research Institute.

Critics also say proponents promised the creation of more than 700 jobs by the end of 2015, but a recent report from the Nevada Governor's Office of Economic Development showed only 272.

In Tesla's transcript of a 2015 fourth-quarter earnings call, CEO Elon Musk said the company's hiring target for the end of the calendar year was 300, and that the factory would meet the company's needs on schedule. Ray Bacon, head of the Nevada Manufacturers Association, said the factory's progress was slowed by weather and hadn't fallen far behind. He also pointed out that many of Tesla's tax breaks are based on performance -- the factory has to hire 6,500 workers within approximately five years and 3,000 construction workers, with half of each group required to be Nevadans. Also, Tesla will provide job training and direct donations to the school system.

While the Tesla site has yet to draw as much interest from outside companies as was projected, Bacon with the Nevada Manufacturers Association said he's confident the state's bet will pay off.

Regardless, Schaus said, "Tesla's kind of got a bit of an image problem with some investors because they get so much from [incentives]. That makes people watch their progress a whole lot more."

That could be bad news for the company, which has staked its reputation on a deal involving several factors outside of its control. For example, its hiring of Nevadans depends on the state providing a large enough skilled workforce, and Bacon said the company's output goals for the battery factory will require it to significantly expand its share of the automobile market.

Bruce McCall, a corporate law attorney with Miller & Martin PLLC, said companies need to be careful to give conservative projections when negotiating agreements.

"Companies I deal with . . . are cognizant of their image," McCall said. "They don't want to be that entity out there saying, 'Oh, geez, we're sorry, we thought we could do X, but we can't.'"

Sports and Entertainment Incentives

Recent deals by cities seeking to keep or attract sports franchises or encourage investment in entertainment venues are also getting a harsh second look.

For example, the city of Anaheim, California, extended for 30 years a gate tax moratorium for Disneyland in 2015, contingent on a $1 billion investment by the park. Anaheim Mayor Tom Tait (R) -- a minority dissenter against the deal -- said the deal risks tying the hands of future voters.

Incentives like those given to Disneyland have questionable value, according to Richard Foglesong, a political science professor at Rollins College and a longtime critic of such deals. He noted that the park's fixed location and pressure to provide new features already create investment incentives for Disney.

"It was not convincing to me that the . . . protection against a ticket tax offered 30 years into the future was necessary," Foglesong said.

Disney and Anaheim argue that the gate tax deal will ultimately bring the city a projected $17.9 million to $26.8 million annually in new revenue. But Foglesong said it's possible that revenue from a hypothetical gate tax might be a greater benefit to the community in the near term.

"That sort of comparative analysis is seldom done, to look at opportunity costs of subsidizing an already existing business corporation versus . . . maybe incentivizing a different business not already present in your city, or using that money as a public investment in schools," he said.

Separately, efforts by some cities to bankroll sports stadiums are seen as unseemly giveaways to wealthy franchises. One example is the $250 million financing arrangement for a basketball stadium approved by Wisconsin Gov. Scott Walker (R) in the summer of 2015, right after he cut education funding. A deal providing nearly $500 million in state and city funds to the Minnesota Vikings for their new stadium in Minneapolis has also drawn substantial criticism in recent years.

Incentive packages can involve both tax breaks and the use of public dollars for construction, and the benefits can be tenuous from an economic standpoint.

"In theory, this is no different than mom and dad agreeing to sign for a child's car, [but] we know from practice that doesn't always work out for the family," said Robert Boland, a sports business expert with Ohio University. "And it doesn't always work out for the stadium, particularly because we see cost overruns," which can lead to the team pressing for even more financing assistance.

State and local policymakers who fund stadium deals are hoping for a variety of benefits, including increased tourism, urban renewal, and increased tax revenue, sources said. But arenas have gotten more expensive, making it harder to recoup investment, according to Boland.

Timothy Bartik, senior economist with the W.E. Upjohn Institute, said stadium projects often just redirect existing local demand for entertainment.

"A lot of the money comes from people who live in the local area . . . if they hadn't spent on the Cubs or White Sox they would have spent on something else locally," Bartik said.

Financing deals "rarely, if ever, work out for governments," according to Rick Eckstein of Villanova University, a stadium finance expert and critic of sports franchise incentives. Governments that create new taxes to pay for stadiums can at least protect their existing revenue, Eckstein said, but as for the theory behind some deals that the cost of bonds can be covered entirely through increased existing taxes spurred by a new stadium, "This rarely happens." He added that sports teams face little risk in many government financing deals.

Experts Say Deals Need Harder Look

Juan Carlos Suárez Serrato, a professor at Duke University who focuses on general tax incentives, said offering large incentive deals to businesses risks making a government beholden to the very business it attracted, while often offering only minimal benefits to taxpayers.

"What we find is there's an increase in employment and wage growth following these kind of incentives . . . but they also lead to a reduction in revenue," Suárez Serrato said.

Some experts argue that bidding wars between states make each incentive agreement part of a vicious cycle. "The cooperative move [for governments] would be to not offer subsidies," said Thomas of the University of Missouri. On the other hand, "if you don't offer incentives, you lose investment," he said.

Supporters say incentive critics ignore the potential that tax deals have to draw industries to regions in need of diversifying, such as Nevada, where gambling, mining, and tourism make up a substantial percentage of the economy.

Ohio University's Boland said stadium deals often get a bad rap when only the immediate returns on the project are considered, and that new sports arenas can help drive redevelopment in underutilized urban areas.

"Newark is a good example, the Prudential arena," Boland said. "More young people want to live downtown now."

And Bartik, although critical of many tax deals, said well-conceived incentives have the potential to help an area.

For example, he said, incentives generally targeting companies in an industry can be a better investment than a major deal with a single company. Also, deals that generally increase funding for professional training and services to businesses can produce a better return, he said.

Other sources agreed. They noted also that there are some positive trends in negotiations, including more tax deals that now involve infrastructure and workforce development with the potential to benefit companies beyond the main recipient of an incentives package.

Meanwhile, Pollina said a recent trend toward more incremental incentive arrangements shows that many governments are pulling back from open-ended giveaways.

"Ten years ago it was hard to find clawbacks, people didn't want to do them," he said. "Since the recession, most contracts have clawbacks."

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