Financial incentives have long been a critical ingredient to economic development strategies. Yet public agencies are under more pressure to prove that incentives are by no means a free lunch.
“A lot of people look at incentives as corporate welfare. Their view is that you are giving companies money, and there is no penalty if they don’t do what they say they are going to do,” says Margo Thomas, an economic incentives consultant at Marlynn Consulting Group in Tallahassee, Fla. Economic development agencies are working to change that view with more accountability, stronger performance requirements, repayment penalties, and greater transparency in how that money is spent.
A Challenge to Grow
States and cities are trying to stretch resources farther in today’s slower economy, as well as craft more effective incentive packages in light of criticism over some high-profile failures. “I definitely think that states and cities are trying to work smarter,” says Mitch Cahn, president of Unionwear. The customized apparel company recently received a $750,000 grant from the Brick City Development Corp. (BCDC) to help acquire its existing 70,000-square-foot facility in the city of Newark, N.J.
The BCDC tapped a federal grant to provide Unionwear with a low-interest loan. Without that assistance, Unionwear most likely would have had to relocate outside of the city. The landlord wanted to convert the property to a residential or retail use, and there is a shortage of alternative industrial locations available. “The city was very pro-business and willing to work with us and help make this deal happen,” says Cahn.
As part of the agreement, Unionwear committed to hiring a certain number of new workers and also maintaining, at minimum, that larger work force — a total of 120 employees — at the Newark location for at least 15 years. “If we don’t do that, then we get a deal that is actually worse than what we could have gotten in the public (financing) market,” says Cahn. “So it is a true incentive, something that is definitely going to challenge us to keep growing,” he adds.
Agencies Safeguard Investments
Given the slower economic growth and budgets constraints still facing many states, there is more pressure on states and communities to stretch the financial resources in their toolboxes. “What has happened, really since 2005 and 2006, is that communities are trying to find ways to invest their dollars more wisely,” says John Lenio, managing director and economist in the Economic Incentives Group at CBRE Inc. in Phoenix.
One result is that agencies are being more selective with those investments, such as focusing on key industries and key employers. In addition, states and communities are working harder to justify spending with a solid return on the taxpayer dollars they are spending. As a result, the potential payback on financial incentives is getting more scrutiny and analysis.
States and communities are trying to figure out how to walk a fine line between providing enough incentives to win a deal, but not to give away more money than they need to. For example, when a company approaches a state and asks for a $1 million cash grant, every state will run their own fiscal impact analysis to determine how much new revenue will be generated from a particular company. “Essentially, the state is trying to determine whether that $1 million is too much of a reach, or if they need to dial down that offer so that it still yields a good return for taxpayers,” says Lenio.
States are doing more homework now in order to do a better ROI analysis. “They are requiring far more due diligence and analytics on how many jobs these incentives are going to create within a community,” agrees Bradley Migdal, managing director of Global Corporate Services at Newmark Grubb Knight Frank in Chicago. States also are considering the direct and indirect impact that a project may have on their state when developing competitive incentive packages.
Economic development agencies are taking a myriad of steps to tweak financial incentives in order to make them more effective and protect their investments. Some states are veering away from non-refundable incentives, such as corporate income tax credits. Instead, there is more emphasis on refundable tax credits or payroll rebates, which are essentially structured as a periodic cash payment or credit in exchange for new jobs and higher payrolls.
Pay for Performance
Economic development agencies are tying incentives to performance, i.e., companies don’t earn any subsidies until they actually hit those pre-set targets. Agencies can still provide $1 million upfront, and then require a company to create 500 jobs over five years. However, it is becoming increasingly common for states and communities to write the check after the company delivers on those 500 jobs.
“That scenario with payment coming after performance is the major trend, because it helps the state or the city underwrite the incentives offer from a cash neutral or positive position,” says Lenio. The agency knows that they will see revenues — whether that is from payroll taxes on new jobs, taxes on additional revenue, or additional real estate taxes from capital investment in facilities — before they have to write that check, he adds.
One performance-based incentive in Florida is the Qualified Target Industry Tax Refund Program (QTI). The incentives are tied to specific performance for creating a certain number of jobs that pay a specific wage. For instance, a company that is awarded $2 million might have to agree to create 25 jobs with an average wage of $45,000. Annual payments to the company may be split into $200,000 yearly installments over 10 years.
“Before you even receive payment, you have to prove that you met those requirements,” says Thomas. Companies file an annual report, and they also have to show proof that they have paid in at least $200,000 in taxes to get that money refunded.
If a business meets at least 80 percent of the goal, they typically get a pro-rated share of the incentive less a penalty. Companies that don’t meet that 80 percent threshold are not allowed to stay in the program. In some cases, the lower target helps businesses that are just getting started and are ramping up production or hiring. However, if companies can’t meet that 80 percent minimum, then their project is terminated and they forfeit any future incentives.
The pay for performance structure does strike a good medium between states and cities using their dollars wisely, while still being competitive and helping companies improve their business case. Some companies like that scenario better because it means less potential penalty risk for them, notes Lenio. “With a pay for performance aspect, it is easier for a company to be assured that they are going to be paid the money if they perform and not have to pay it back,” he adds.
Next: Ford Delivers ROI
Ford Delivers ROI
Certainly, cities and states are facing stiff competition to attract and retain businesses today in a climate where there are so many choices both in the United States and internationally. Financial incentives can be a critical component that gives states and communities an edge in landing new business. At the same time, agencies are keenly focused on mitigating risks and protecting their investments.
One notable example of how states are leveraging incentives to generate a sizable return on investment is a package that Kentucky created for Ford to retain and grow jobs at the automakers two Louisville facilities. When the economic crisis hit in 2007, Ford was faced with deciding where to focus production and where to close plants.
Ford operates two manufacturing facilities in Louisville. Its Louisville Assembly Plant, in particular, was at risk; it was an aging facility that was producing the Ford Explorer, which was seeing declining demand. The state of Kentucky put together a financing package that enabled Ford to completely retool the plant. The new global platform assembly line can be adjusted to accommodate different car models. The plant, which reopened in 2012, is currently producing the 2013 Ford Escape.
“In essence, we took a plant that was at risk of being closed and we turned it into one of their most modern facilities that can now produce product for a global market and really secured that investment and Ford’s presence in Louisville for years to come,” says Erik Dunnigan, commissioner of the Department for Business Development at the Kentucky Cabinet for Economic Development. At the same time, Kentucky did not have to spend any money up front. The incentive package is structured so that Ford will recoup some of its investment by getting a share of future tax revenues as the company puts its people back to work in the new facility and continues to hire more individuals.
As part of that economic development effort, Ford plans to invest upward of $1.2 billion between its two facilities in Louisville and employ nearly 8,000 people. Ultimately, Ford will reclaim up to $240 million over a 10-year period. “A lot of times when people see those numbers, they think we are writing a check. That is not the case,” says Dunnigan. The reality is that the state does not start paying out until the employer has made the investment and ramped up and created jobs, he adds.
Penalties and Clawbacks
At the end of the day, incentives are offered for jobs. “States are looking for jobs any way that they can get them, and the incentive environment is more competitive than ever,” says Migdal. That being said, states and municipalities are under more pressure to be more transparent and show that these programs are helping to drive economic growth.
Most incentive agreements have very strong reporting requirements. There is usually an annual report and a closeout report that is filed related to every incentive agreement. The state of Illinois’ Economic Development for a Growing Economy (EDGE) program, for example, requires online reporting that makes companies receiving incentives accountable for the results. “Any company that receives an incentive has to file a report online. So, there is complete transparency on what is offered from the state,” says Migdal.
Agencies also are strengthening the penalties and payback provisions for those firms that don’t deliver on their promises. Essentially, if a company does not perform, they are going to have to pay back the incentive. Over the last five to six years, there has been an added focus on making sure that the repayment provisions are watertight, notes Lenio.
Slower economic growth, as well as business failures that have left communities holding the bag, has brought that issue of mitigating risk to the forefront. Every state and community is highly focused on creating long-term partnerships. Yet states and cities want a guarantee or safety net to know that they can go back and get their money just in case a company does not fulfill its promises.
“If a company does not hit its jobs or capital investment target, then — in every agreement that we work on — there is always going to be repayment scenarios,” says Lenio. “So very rarely is there a case where a company can cut the cord and be done, and not owe anything.”