David B. Munson, Program Development Associate, Center for Automotive Research (Fall 2012)
A year ago, one of the leading automotive states was reluctant to consider economic development incentives for parts and components suppliers' expansion projects. Automotive parts manufacturing was not even on its list of "target industries." Only those projects considered as "advanced manufacturing" or diversification to reduce dependence on automotive were being targeted. Now, however, the rapid resurgence in vehicle sales has erased any ambivalence concerning the automotive parts and components sector!
Now the question is, "Can the supply-chain expand fast enough?" Automotive states and communities are competing aggressively to win supplier projects of all sizes and descriptions. If R&D, advanced manufacturing, lightweighting, more fuel-efficient powertrains, or diversification is part of the project, this increases interest and can raise the potential value of state and local incentives.
Incentives are primarily based on two criteria: jobs and investment. How many permanent, full-time jobs will you create (at what wage and benefit levels)? What is the planned capital investment? Job creation and investment may be phased in over three to five years. Incentives are scaled based on the total economic impact the project will have on the area. Job retention is seldom rewarded directly, but can be a subjective factor (and potentially a "multiplier") in how aggressively a region competes for a job creation/investment project that incorporates retention.
Incentives can benefit an automotive supplier's expansion or new location project and operations in several ways, including:
- Cost avoidance, cost reduction, or refunds covering periods up to 20 years;
- Work force recruitment, development, and training (no cost);
- R&D/product improvement assistance; and
- Improved public infrastructure, which can include on-site improvements in some instances (e.g., getting a site ready for construction, building the base for interior roads and driveways, storm water systems, and even building or rebuilding a parking lot).
Grants and loans reduce upfront costs, enabling a supplier to stretch and retain precious capital during the early stages when cash flow is negative. Saved capital can be used for additional investment in machinery and equipment or added to working capital as additional growth requires. Refundable and nonrefundable tax credits, on-the-job training grants, reductions in property and sales taxes, and special utility rates directly impact the bottom line as the supplier meets phased job creation and investment commitments.
Statutory or Discretionary
Incentives can be categorized as statutory or discretionary. Statutory incentives identify eligible industry sectors and subsectors by NAICS/SIC codes or in narrative form, such as "headquarters," "research and development facilities," etc. There are job creation and capital expenditure thresholds. Awards are objective: if a project meets the eligibility requirements and a timely application is submitted, the supplier should get the incentive. Typical examples of statutory incentives include:
- Property tax abatements;
- Sales tax abatements on utilities (especially gas and electric), new M&E (or equipment relocated from out-of-state), and project construction materials;
- Job training; and
- Nonrefundable credits against state income, excise, or franchise taxes; these credits are generally "use them or lose them" on an annual basis; a few states allow carryforward.
The justification for discretionary incentives is often, "But for this [incentive] the project would not have located here." Proof of one or more of the following is required:
- Out-of-state competition for the project;
- A competitive disadvantage at the preferred location vs. a viable alternative; and/or
- Incentive offers from other states.
Discretionary awards are subjective (within limits) and vary in type, structure and amount based on: (1) the company's specific need and justification for incentives to overcome a disadvantage in the location or a gap/obstacle to the project; and (2) the state's and community's judgment as to what it will take (and what it is worth) to win the deal. There are firm eligibility requirements, including higher job creation and capital expenditure thresholds than most statutory incentives, periodic monitoring of job creation, quality of jobs (average wages and benefits package), capital investment, and other objective data. A baseline for the supplier's statewide employment is usually established. Permanent job losses at other facilities in the state are deducted from net job creation at the expanded/new facility, resulting in reduced incentives. Examples of discretionary incentives include:
- Forgivable loans/ grants;
- Refundable state tax credits (if the supplier does not have a state tax liability in any year, the state issues a refund check); and
- Investment tax credits against state taxes.
Discretionary awards are performance-based: the supplier receives benefits after job creation and investment commitments are met. In a recent example, an automotive supplier willing to create 350 jobs was offered a forgivable loan with no payments or interest for up to three years. As soon as the supplier reaches 350 new jobs, a repayment obligation with five annual installments kicks in. For each year the supplier maintains 350 jobs, 20 percent of the loan will be written off, and 100 percent of the loan will be forgiven if 350 jobs are maintained for five years. The upfront loan supplied cash to enable the project to commence. The real enticement for the business to choose that location over a competitor was the opportunity to turn the loan into a grant through performance. If the company fails to create 350 jobs by mid-2015, the obligation converts to a regular loan and must be repaid in 60 monthly installments. In this case it was all or nothing. In other locations pro-ration is permitted, although there is an absolute minimum (say, 60 percent of the job commitment) required to trigger it.
Some states tie grants and refundable credits to jobs paying 130 percent or more of the average hourly manufacturing wage in the labor shed. The wage requirement in the first year might be 90-100 percent of the average, but must rise to the target level over the next year or two. This might be attractive to high-paying sectors like tool and die or precision-machining operations.
Knowing What to Look Out For
No matter what type of incentive is offered, the first question you should always ask is, "What is the approval process and how does the timing work in respect to our commitment to the project and commencement of investment and job creation?" Some states and communities only require written notification before committing to the project to preserve eligibility for subsequent consideration of statutory incentives; others require prior full approval by a public or quasi-public board. Discretionary incentives require prior approval (in some form) before a company makes an irrevocable commitment or issues a public announcement.
Expect investigation into "business integrity and financial viability" for statutory incentives, and a much deeper look into the company and its owners and officers when discretionary incentives are on the table. Some states expedite the incentives process by issuing letters of intent in 7-10 days describing specific offers, contingent on (1) a satisfactory report from their due diligence process; and (2) commitments by the company to specific "net" new job creation, maintenance of baseline employment plus new jobs over a period of years, and capital investment as detailed in the project plan and incentives agreement.
Many incentives, especially discretionary, high-value and/or those providing benefits over several years (like a 10-year tax abatement), have "clawbacks" or other sanctions that penalize companies that fail to meet their employment and investment commitments. As many incentives are now performance-based, clawbacks may be less of an issue in the future. Most projects receive property tax abatements and these, in particular, may have "repayment" requirements. In some places that means that a company that falls below its commitments in (say) year five of a 10-year tax abatement will have to repay the tax savings for the current or immediate past year; in other areas the repayment might stretch all the way back to day one. Some terms and conditions may be negotiable up front.
Some states allow "layering" of their high-value incentives; they will offer multiple programs that may have individual limits, but can be combined to produce a higher total value. If limited to one state-level incentive, pick the most valuable offer that is also the best overall fit for your project. There are incentives that look good on paper or in a news release, but may have little or no value to your specific project.
They are offered in good faith because they fit many projects - and maybe they will fit your company in the future. For example, if you are offered millions of dollars of credits against a state tax that is only imposed on products made and sold in that state, and 90 percent of your sales are outside, then the credit has little value to you at this time.
Whether to use a site selection or incentive procurement consultant is a topic for another article; there are qualified consultants to handle any project from the largest to the smallest and local to global. If a company makes location decisions frequently, it may develop some in-house expertise. But the learning curve and time commitment each new location demands may make it wise to find a consultant who specializes in auto supplier projects. Consultants work exclusively for you.
Without exception, the one agency you must know is the local economic development office. Expect annual meetings and periodic check-ins via phone and email. Join the organization, if possible. Build a relationship. Most economic developers are problem-solvers. Challenge them to help you grow and they will almost always amaze you. They will also connect you to everyone else you need to know to put a successful project together in their region and state. Local economic offices work for the community, but many are partially supported by business members. That makes them a "dual agency" of sorts - but they do not work exclusively for you. You are their customer and you can expect them to treat you as well as you treat your customers.
Economic developers and government officials at all levels understand that facilitating incentives should result in a good business deal for each party. Undertaken on a straightforward basis, it is a fair exchange.