Corporations shopping for locations for major facilities can get unprecedented financial incentives from state and local governments. But how much taxpayer money can companies take before it looks more like 'corporate welfare' than an economic win for both sides?
The economic development game is a quagmire in which business ethics are critical but murky, incentives look a lot like bribes, and pulling strings and gaining preferential treatment can make a company look heroic if the spin is right. In this morass of questionable legitimacy, corporations are cutting record deals with states, counties and cities that influence where they will locate new facilities or, sometimes, whether they will close existing ones.
The cinematic anti-hero of "Wall Street," Gordon Gekko, struck a chord in the 1980s when he announced that greed is good. That principle is being tested today as companies and communities jockey for advantage in a bare-knuckled process that, when it works, lines some pockets but also forges an alliance between government and business that brings prosperity to both parties. But economic development raises the question of how far private, for-profit businesses should go in taking massive handouts of taxpayers' money. Is "corporate welfare," as some critics charge, an abusive practice? Or is it good economics, democracy and free markets at work?
Raising the Ante
The players in this high-stakes game do agree about one thing: The stakes are getting higher. High enough to have even some of the pioneers in the economic development game shaking their heads. Charles S. Way Jr., Secretary of Commerce for the state of South Carolina in Columbia, is known as an aggressive and successful player when it comes to attracting large corporate facilities. The state, which has a population of just 3.8 million, drew more than $40 billion in investments and added more than 200,000 new jobs during the 1990s.
Still, Way confides, "We are about to lose one project that we dearly wanted. It's going to Mississippi because that state will hand over, on the day the deal is signed, a check for $120 million. And we lost another one to New York, of all places, because they also wrote a large check up front. It would have meant 50 jobs, but it's becoming just too expensive. We can't match those prices.
"Companies today are looking for deals that give them money right away rather than ones that pay them over time. The most powerful financial incentives reduce or eliminate up-front costs for the company," he adds.
Prices may be high, but so are returns. "It may seem like a lot of money," concedes Tom Cunningham, vice president and associate director of research at the Federal Reserve Bank of Atlanta, "but it's good economics for a community to decide what a new employer is worth." One reason prices are high is that past economic development investments have paid off handsomely for communities. Even some of the most aggressive bids in recent history have been winners, and large regions of the country have seen their economies revitalized by farsighted investments that raised eyebrows when they were made. This strong track record is feeding the current bull market in economic development spending.
When landing one major new employer means the difference between life and death for a small community, decisions aren't always rational. But a municipality's desperation can spell good news for corporations seeking to build. One cash-poor community in Oregon decided that its whole future lay in closing a deal with one company, so rather than be outbid, it came up with "an enormous cash incentive package" that cemented the deal, reports Art James, business development manager of the Oregon Economic and Community Development Department, a state agency in Salem. "By any calculation of return on investment and economic benefits from the new jobs, it will take a very long time for that community to get back what it has spent. But it was their future, and they decided they needed to take control of it."
That decision had the effect of raising the bar for other deals throughout the region. "Consultants coming to us now always cite this deal and ask for something comparable, even though it was an aberration we just can't afford to match," James reports.
Crazy for Tax Breaks
A lot of the financial incentives negotiated today come in the form of tax breaks. "Everyone starts out thinking they should pay no taxes for five years," reports Reagan Wilson, CEO of Stanislaus County, Calif., in Modesto. However, putting too much emphasis on tax breaks can be short-sighted. Stanislaus County offers no tax abatements beyond those provided by California, Wilson reports. "We explain that we need those tax dollars to maintain the support infrastructure that attracted them to our county in the first place," he says. "They're businesspeople, so they understand this."
"You're dealing with a naive company when their first question is 'What financial incentives can you put on the table?' " says James. "Financial incentives should be the tiebreaker at the end of the process, not what you lead with. What's more important are the size and caliber of the work force, the transportation networks, utility rates and the business climate. The purely financial incentives won't make the deal work over the long term."
Most finance executives are smart enough to pick a few sites that make sense from a business standpoint and then invite the favored communities to offer incentives to get the facility, notes Cunningham. "No amount of incentives will attract a salmon cannery to Montana," he argues.
But tax abatements have become an addictive sweetener in the bidding process, and they almost inevitably end up on the table. Executives shopping for a new site are expected to bring some home. One of the most potent tax abatements now being offered allows a favored company to keep most of the state income tax it withholds from its employees.
Programs such as the Oklahoma Quality Jobs Act and the New Jersey Business Employee Incentive Program let states collect personal income taxes from employees of new ventures and then rebate the money back to their employers. Such incentives move businesses, says Jim Schriner, partner in the New York office of Deloitte & Touche LLP. "You might get back $1,800 per employee annually for 10 years," he suggests. "For 1,000 employees, that would be $1.8 million or $18 million over 10 years. It adds up."
That's one reason businesses are moving labor-intensive operations out of New York and into northern New Jersey. Now New York is fighting back with enterprise zones, Schriner notes. And Pennsylvania abates all state taxes for organizations that build a qualifying project in one of 126 'Keystone Opportunity Zones,' he adds.
But incentives paid out as tax credits may be worth less than their apparent value. "Companies love tax credits, but often they bargain for more than they can use," Schriner notes. "Press reports of the value of incentive packages tend to be exaggerated. Most companies use only half of the incentives they negotiate, but you don't hear about this. It's not all real money."
"Tax breaks are always important, but their importance is often exaggerated," argues Mike Eades, president of South Carolina's Florence County Economic Development Partnership. "When you look at the overall costs of an operation, taxes are a small part."
Other incentives that don't drain cash from the community can attract corporations by saving them money. For example, a locality might expedite the building permits and regulatory approvals necessary to get a facility built. Some jurisdictions approve projects in phases rather than making companies get a whole project approved before it can start, Schriner explains. Expedited approvals got BMW's 1 million-square-foot plant in South Carolina built and into operation in a record 23 months, he says. "That is worth a lot of money."
Stanislaus County, Calif., compensates for not offering tax breaks by cutting bureaucratic delays in the issuance of permits and in regulatory inspections. One project that offered 300 new jobs was slated for nearby San Joaquin County but ran into red tape there that was putting it behind schedule. The company's frustrated managers proposed moving the facility to Stanislaus County if they could get all the regulatory issues resolved in a week. "Within an hour," Wilson recalls, "we handed them a signed letter promising full resolution of building permit and regulation issues within a week. And then we worked overtime and got it wrapped up in four days."
Some communities provide a dedicated ombudsman, who is on-site once the premises can be occupied, specifically to cut red tape and run interference with the local regulatory and permitting agencies. In some regions, businesses can even negotiate a most favorable workers' comp classification that saves them money until they establish a track record for their classification to be based on, Schriner points out.
'Take It or Leave It' Finds Takers
With so many possible incentives and so many variables, how do finance executives sort through the offers and make the best decisions for their shareholders? Some companies simplify the process by taking a standardized approach. Although Sykes Enterprises Inc., a computer-support business in Tampa, Fla., has a global reputation for its success in getting communities to fork over free land and buildings and generous tax abatements, the organization engages in very little negotiation, according to David P. Reule, managing director of Sykes Realty Inc. That's because the company makes sure there is just one package on the table the Sykes package. "We don't shop one community against another. Either they can do it or they can't," Reule says.
Sykes builds two kinds of buildings: 120,000-square-foot warehouses and call centers that are packed with people answering computer help lines. The warehouses need to be at key distribution points near major interstate highways, and they need to have good access for trucks. For its call centers, Sykes needs a large work force of educated people with good personalities and state-of-the-art fiber-optic lines, Reule notes.
Sykes owns and operates all of its own real estate. It doesn't outsource anything or lease space in its buildings to other tenants. In addition, Sykes does all of its own site selection and negotiation, rather than following the popular practice of bringing in outside consultants who are expert in negotiating incentives.
Rather than coax, twist arms or engage in brinkmanship, Reule presents each community he considers with an economic proposition. "We know going in exactly what incentives we need to remain competitive in our marketplace, and we spell that out for them up front. Most of our competitors locate in major metropolitan areas. Typically we do not. It costs more money to set up and do business in the rural communities we prefer, so we need to get certain incentives to offset that increased cost so we don't start out at a competitive disadvantage."
Does Sykes, by forgoing bidding wars and bargaining, leave money on the table? Sure. "We don't try to drive the best bargains," Reule concedes. "The incentives we get are often much less than communities typically offer to attract new facilities like ours."
Because the stakes are so high and there is a premium on secrecy, most large corporations pay consultants to negotiate their incentive packages, reports South Carolina's Way. "A lot of them are hired from states' economic development staffs. They know the rules and where the skeletons are hidden. They can drive a hard bargain."
Getting the best deal requires a combination of outside consultants who know the game and inside managers who know the company, says Schriner. "You have to move quickly. There isn't time for insiders to get up to speed about the negotiating process or for outsiders to get up to speed about the company's business and accounting practices and tax status. Consultants have the creative ideas, and insiders know the facts. They have to work together."
Computer ROI models can also help advise the process. "We use an economic impact model," reports Eades. "We require each prospect to complete a questionnaire about their investment, the jobs they will create and so forth, and we feed the numbers into our model. It gives us a pretty good idea of what we will get back on our investment and how high we can afford to go." But Oregon's James has not been impressed with these models. "We rely on consistency and our experience," he says.
From the corporate perspective, Schriner dismisses computer models as useless. "There are too many variables," he observes. "This business is an art, not a science."
Addressing the Smell Factor
While most economists credit economic development efforts with bringing prosperity to once-poor parts of the country, the wheeling and dealing, the attitude that the best strategy is to do whatever it takes to win, and the veil of secrecy that shrouds negotiations have left something of an odor around the process.
In the final stages of negotiation, a company that will be transferring executives into the new locale may ask for quick membership in country clubs that have waiting lists or preferential admission of employees' children in local private schools. Communities almost always find ways to grant these requests, Schriner says. But although such practices are certainly preferential, they're not illegal, he insists.
While feeding at the public trough and making deals for special treatment for executives may be perfectly legal and even economically noble in terms of the long-term benefits to both sides, the process is so tainted that most corporations don't want their auditors to know what they're up to until their financial statements reflect the deal. That's why Schriner's practice consists mostly of firms Deloitte & Touche does not audit.
"Our clients know that the announcement of a major project triggers a requirement for reserves that could have a negative impact on corporate bonuses. So they may delay the announcement for a couple of months. But if the auditors knew about the project, they would require them to take the reserves right away. There are advantages to keeping your auditors in the dark. That's why we work mostly for non-attestation clients," Schriner admits.
This is the business of politics and the politics of business. Finance executives can't afford to turn up their noses at incentives that can improve the profitability of a major project, but they can focus on long-term success instead of trophy deals larded with flashy tax rebates and up-front checks. Then both sides will truly win.
Rocky Mount's 'Field of Dreams'
Struggling Rocky Mount, N.C., had just landed a deal that was expected to bring economic prosperity to the region when disaster struck. Contractors were pouring the foundation for a new $80 million distribution center for QVC Inc., the company that produces the Home Shopping Network a facility which would employ 800 when Hurricane Floyd roared into town in September 1999. Massive floods plunged nearby communities under several feet of water.
Skeptics immediately speculated that QVC would cut its losses and pull out of the crippled community. After all, this was the hard world of business. But that didn't happen. Instead, "QVC executives were on the phone with us every day, asking, 'What can we do? How can we help?' and saying, 'We're in this with you,' " reports Oppie Jordan, vice president of Carolinas Gateway Partnership, a two-county economic development operation. "QVC employees in other locations collected money and clothing and sent them to us. It was heartwarming."
QVC did not come cheap. Edgecomb County gave the corporation, at no cost, a prime 273-acre plot of land with full utility connections and good roads that link the facility to nearby interstate highways, Jordan says. And when QVC reaches its goals of investing $80 million in the facility and creating 800 new jobs, the county will hand over a check for $300,000. In addition, because Edgecomb is a tier one (most needy) county, QVC qualifies for a tax credit from the state of $12,500 per job. For 800 jobs, that means a credit of exactly $10 million.
Did Edgecomb County and North Carolina pay too much? No way, Jordan insists. "You have to meet the competition, or you don't get the business. But we had calculated the impact of the facility on our tax revenue and knew we'd come out ahead."
Secrecy was so tight that Jordan and her colleagues didn't know until the last minute that the anonymous prospect whose hired consultants they were negotiating with was QVC. That's when the company announced to local officials that it would locate in Edgecomb County if the locals could meet its list of demands. They did, and QVC's large, sophisticated facility was operating just 13 months after the signing of the agreement on July 19, 1999.
"It has been for us," Jordan concludes, "a 'Field of Dreams' experience."
Borrowing Under a Tax-Free Umbrella
One financial incentive that is not controversial is for a state or municipality to lend its bond-issuing authority to a private corporation. A municipal authority can sell bonds under its rating and tax-exempt status, then turn around and lend the proceeds to a private company for use in a qualifying project. This practice isn't controversial because the federal tax code spells out in excruciating detail exactly which private corporate projects qualify for the favored industrial revenue bonds (IRBs) or industrial development bonds (IDBs). No wheeling and dealing is involved, but the savings can be substantial.
The definitions of qualifying projects are complex, but IRBs and IDBs generally provide seed money for small manufacturers or manufacturers with small operations in the political jurisdiction of the issuing authority. To be eligible, a manufacturer can't have capital expenditures exceeding $10 million, going back six years and forward three, in the county issuing the bonds, explains Rick Thomas, senior vice president at Wells Fargo Public Finance in Seattle. His unit helps public finance authorities issue bonds.
Tax-exempt IRB financing was critical to luring three companies to the state of Washington, reports Jonathan Hayes, executive director of the Washington Economic Development Finance Authority in Seattle. Nature's Path Foods, a large Canadian manufacturer of organic breakfast food, used the proceeds of two issues to build a new facility in Blaine that employs 54. A modest $4.6 million offering enabled a nonprofit firm that recycles office waste to begin operations in Seattle; proceeds from the recycling finance a drug and alcohol rehabilitation program. And a $7 million IRB offering financed a major plant expansion for Quebec-based Canam Steel and brought 165 new jobs to Yakima, Hayes recounts.
If Washington hits its capacity caps, which hasn't happened yet, projects in poorer parts of the state will be given priority, Hayes explains. Borrowers under IRB financing in Washington can pick their own bond counsel, trustee and underwriter; the state does not use captive service providers, he adds. Bond issues generally carry a variable rate, which in early November was 4.45 percent. "If you tack on another 1 percent for the letter of credit, you're looking at an all-in financing rate of about 5.5 percent," Hayes estimates. That's a savings of about 220 basis points over what a medium-rated corporation would pay on bonds it issued itself.
Since the issuing authorities must repay the bonds at maturity, borrowers must provide credit assurance, usually a bank letter of credit. The authority passes through the bond proceeds to the borrower, then transfers the borrower's loan repayments to the bond holders with the aid of a bank trustee. For this, they charge only a small fee (typically a quarter of a basis point) to cover their expenses. Essentially, they serve as conduits, Thomas explains. For projects that qualify, it's subsidized financing.
How Honda Arrived in Lincoln
One of the big plums of 1999 went to tiny Lincoln, Ala., (population around 4,000) when American Honda Motor Co. Inc. announced that it would invest $440 million in a 1.7 million-square-foot manufacturing plant on a 1,350-acre site that would employ 1,500. A Honda team that included finance, engineering, operations, legal and communications personnel, as well as outside consultants, made it happen, says Jeffrey Smith, senior manager for corporate affairs and communications in Torrance, Calif. That plant is now under construction; it is scheduled to begin production late in 2001 and reach full capacity late in 2002.
Smith explains what went on behind the scenes. "We started our search in all 50 states. When we narrowed the search to a few states and looked at their incentive packages, we found there wasn't much difference. Incentives were not a factor in our choice of Alabama. What mattered to us were the size and quality of the local labor force and a good transportation infrastructure. We also looked at weather and even seismology.
"Everyone understood that a plant this large would require infrastructure development and other incentives. But we did not encourage a bidding process or bargain with rival states to see how much we could get." The incentives include tax abatement, but "that was low on our decision tree, and all the finalists offered about the same tax advantages," he notes.
The process was wrapped in secrecy. "It's hard to make a rational decision when you're on the nightly news and outside influences are unleashed. So we traveled incognito when we visited various sites," Smith says.