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Sunday, June 3, 2012

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.

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