Keating: Tax Abatements and TIFs
The following is based on comments made at a foundation luncheon April 12, 2018, in Fort Wayne.
by Barry Keating, Ph.D.
Jerry Brown was elected governor of California in 1974 and again in 1978 before busying himself as mayor of Oakland. Californians in 2010 apparently wanted to return to the days of “Governor Moonbeam,” as Brown was affectionately known, and elected him governor again. Perhaps dating Hollywood movie stars and hanging with Cesar Chavez helped endear Brown to California voters.
But the Jerry Brown that won the hearts of voters for the third time appeared to be a different Jerry Brown. He campaigned on eliminating 749 redevelopment agencies in California. This was not the Jerry Brown of old.
The governor himself had created many of those redevelopment commissions ostensibly to raise funds to remove urban blight. His decision to eliminate the redevelopment commissions was backpedaling. Brown realized both that urban blight was not affected and the tax base did not increase; instead, taxpayers were given the opportunity to pay higher taxes and witness more urban decay.
Brown is an astute politician; he realized that public opinion had changed and nongovernment solutions may be more effective. He campaigned on that basis and won.
The South Bend Experience
In 2011, I wrote an article in The Indiana Policy Review titled “South Bend Learns a California Lesson.” The article was inspired not just by Brown’s actions, but also by the College Football Hall of Fame debacle in South Bend. South Bend city fathers and “economic developers” decided in the early nineties to create a big-time attraction in the downtown central business district that would draw traffic and customers after previous attempts at redevelopment by the city government had failed. After all, we’d already tried (at great taxpayer expense) one-way streets and a downtown mall that had no streets.
Enter the National Football Foundation (NFF). It had a great “shovel-ready” idea for the South Bend redevelopment commission. The NFF would dump Kings Mill, Ohio, its current location, and move lock, stock and barrel to South Bend. Of course, the people of Kings Mill would be left with a useless building and a bad taste in their mouths, but the move would be good for the NFF.
By 2011, the NFF had seen that South Bend was no better than Kings Mill, and off it went to Atlanta where the Hall remains. But a trail of devastation remains in South Bend and Kings Mill.
Throughout the 1990s in South Bend the city spent millions of dollars to please the NFF and make it feel welcome. In 1994 alone, just a year before the Hall opened, the city spent $19 million for the Hall.
The Economic Club of Michiana at this time learned from city officials how the Hall was to be financed; members were aghast at the opulence of spending compared with the South Bend tax base. The Hall was touted as the most important service needed by South Bend residents. It was quite the opposite. Most residents never ventured into the Hall; the Hall drew few outside visitors, and by 2009 it had become a liability to the city of massive proportions.
The city of South Bend still owes $3 million on the vacant 52,000-square-foot building and has been paying $100,000 per year just to maintain the building. What the NFF and the developers left behind was urban blight in the central business district. Presently, South Bend taxpayers service bond payments to finance a vacant eyesore across the street from another developer’s dream: the South Bend Century Center Convention (an underused publicly funded building).
Government redevelopment commissions rarely make good choices. They rarely identify winners. And like California, Indiana’s redevelopment commissions deserve to be eliminated.
But South Bend isn’t the only Indiana city to be wooed by the Music Men of development commissions. Barack Obama visited Elkhart, Indiana, twice in 2009. Elkhart had the highest unemployment rate of any city in the United States (about 20 percent). Obama told the people of Elkhart that this was unacceptable and he had the solution for Elkhart and the rest of the United States.
Every state had “shovel ready” projects and Obama was ready to fund them with a stimulus package of gargantuan proportions. While in Elkhart he visited one of the plants that would surely lead the charge in putting people back to work; it was a new electric vehicle plant, one of three in the area to receive $50 million in government funding. Obama also promised to grant special status to electric vehicles for tax credits (i.e., abatements) so that these Elkhart plants could flourish and provide jobs long into the future.
In 2012, CBS News visited the electric car manufacturing site. What did it find? “We recently visited Think City’s Indiana plant, and here’s what we found: a largely empty warehouse.” The company that had received the government benefits had gone bankrupt. The Elkhart location represented its fourth bankruptcy. Once again, the government made bad choices; it rarely picks winners.
Now it’s 2018 and Elkhart has indeed changed. The unemployment rate is just 2.9 percent. But “according to a December 2017 report by WorkOne, there are approximately 9,500 unfilled jobs available in Elkhart County.” In other words, the true unemployment rate is zero percent.
If the three electric vehicle manufacturers (now long gone) didn’t hire people, who did? Did the stimulus package have the astounding effect of dropping the unemployment from 20 percent to zero percent? No, the answer is simple. The market, in spite of the drag of a bloated stimulus package, took hold in late 2016 and unemployment dropped while the workforce increased in size. But that was not due to any redevelopment commission doling out tax abatements and creating TIF (Tax Increment Finance) districts.
The $50 Bill
Dr. Gordon Tullock, an economist in Virginia, would auction off a $50 bill in class early each semester. He was making a point. These auctions started with Dr. Tullock handing out plain white envelopes to everyone in the class. The students were told that the highest bidder would win the $50 bill. The rules were that each student would place a bid in cash in the envelope with their name on the outside. The envelopes would be collected and the winner would be chosen.
There was a catch: Tullock informed the students that he was allowed to keep all the bids that were placed in the envelopes. So the winner would get $50 less what he or she placed in the envelope, losers would lose the amount of their bid.
Tullock ran the auctions to see if the results would match what economists thought would happen. However, when the auction was explained to economists, they disagreed about the likely outcome. Some believed that Tullock would lose money every time the auction was held. Others were not quite so sure.
The $50 bill, Tullock would explain, was an economic “rent” that developers receive if awarded tax abatement or TIF status, or another government subsidy. Rent here is not meant in the usual sense. Economic rent is any payment to an owner or factor of production more than the costs needed to bring that factor into production. In one sense, it is an unnecessary payment or prize.
Tullock rarely lost money. Once an economic rent is created, individuals will bid on the chance of receiving the benefit. Resources that would have been otherwise allocated by Tullock’s students or by the firms who openly seek abatements are essentially wasted. Furthermore, in the case of government, taxpayers, misled by the promise of increased tax revenue in the long run, are expected to assume the risks and fund the prizes.
I do not believe the government always makes poor choices in all things, but there is a better way of making economic choices. We have markets, and markets give individuals exactly what they are willing to pay without the need for any government official to offer prizes. If South Bend residents had truly demanded a College Football Hall of Fame, some entrepreneur would have provided it. If Elkhart was truly the best location for a needed electric auto plant, the market would have placed one there.
Market versus Government Failure
Economists argue that “market failure” is the main reason for the government; they argue that private markets do not build roads, provide clean water, eliminate sewage and enforce the law. We need government to do these things. These economists are correct. Each of these appropriate roles for the government was detailed long ago at Wabash College in Crawfordsville by Dr. Milton Friedman when he presented a set of talks later published as “Capitalism & Freedom.” Friedman listed just three areas of appropriate government action:
- The government needs to act as a rule-maker and enforcer;
- The government should provide public goods (e.g., roads, bridges);
- Finally, the government should sometimes operate paternally (e.g., for children who cannot fare for themselves).
These three areas Friedman detailed were appropriate for government action because markets had no incentive to provide these goods and services. It was the government’s duty to step in and see to their provision. But the government, according to this argument, should not provide goods and services whenever there is an incentive for the market to act.
Public Choice economics is one alternative way of looking at abatements and TIFs when compared to how they are presented to the general public. Public Choice is sometimes defined as the application of economics to politics. It uses the self-interest postulate of microeconomics and extends it to politicians and their commissions; it suggests that the outcome of government commissions is the result of the interaction of self-interested voters, politicians and bureaucrats.
Public Choice emphasizes “government failure.” Government failure happens when the government steps in to provide goods and services that would be provided if the market determined there was a reasonable chance of covering costs and earning a profit.
The College Football Hall of Fame represents government failure. If there had been a reasonable chance to make money by providing people the opportunity to visit a College Football Hall of Fame, the market would have built it. Walt Disney, on the other hand, believed people would pay to visit the Magic Kingdom; he was correct, and he reaped the rewards. No government action was necessary.
But if Disney had reckoned incorrectly, who would have borne the costs of the mistake? Disney and his investors would have lost a great deal of money. The market rewards winners and penalizes losers. But who lost when the College Football Hall of Fame turned out to be a massive mistake? The developers didn’t lose; they were paid and went on their way to the next project. The politicians didn’t lose; the same party has been re-elected ever since in South Bend. The National Football Foundation didn’t lose; it moved to Atlanta; the academic economists who authored the “impact studies” didn’t lose.
The taxpayers of South Bend, however, did lose; they continue to pay for “government failure.”
In summary, the more discretion government officials are given to create TIFs or grant abatements, the larger the incentive for individuals and firms to lobby them to gain influence, and the larger the opportunity for wasteful spending. It’s just like the $50-bill experiment. The waste exceeds benefits. There is no reason to expect that a rent-seeking environment will lead either to an efficient set of decision rules or the awarding of abatements to those projects that have the largest social payoff.
Redevelopment commissions that step outside the bounds of Friedman’s three roles for government set up an environment conducive to those pursuing rent-seeking monopoly power; the taxpayer is sure to lose. Governor Brown came to realize this truth.
When rents are available, we should expect to see the following from government officials and redevelopment commissions:
- Rules set to favor certain groups and individuals;
- Changes in zoning rules;
- Indefensible weights assigned to favored industries;
- Illogical procedures for measuring impact;
- Distortions in estimating capital and labor costs;
- Arbitrary rules in allocating contracts.
Once politicians assume responsibility for the outcome of a particular situation, they find that they have made an almost irreversible decision and one which, over time, will open taxpayers to unlimited liabilities. Whatever the economic situation, it will be politically impossible to stop increasing the number of firms eligible for tax exemption because doing so will lead to the appearance of abandoning the town’s economic well-being.
But surely TIFs and tax abatements will increase the aggregate amount of investment? No, investment is limited by the pool of savings; TIFs and tax abatements do not increase the pool of savings and therefore cannot increase investment.
An Alternative Solution for Market Failure
Entrepreneurs compete as vigorously for government-created rents as for market-generated profits. That is the reason programs that are meant to increase wealth may result in staggering amounts of waste as firms compete for subsidies (just as we saw in the $50 bill experiment). But rent-seeking inefficiencies can be avoided if a resource that has some use value is auctioned off by the government or allocated by some quasi-market process. The telecommunications industry that may serve as an example.
After Marconi demonstrated the possibilities of carrying intelligent communication over radio waves, a new industry emerged and there was money to be made. For most of the past century, wireless access and radio became ever more important. In the early 1920s, commercial radio broadcast stations in Chicago (WGN and WLS) began to interfere with each other’s broadcast; the interference was probably not intentional, but it was real due to the closeness of broadcast frequencies.
The government solution was to declare that the airwaves were a public resource and government should allocate use to responsible parties. In other words, the government recognized a natural monopoly and decided to grant rights to its use. The Federal Communications Commission (FCC) would grant licenses (a limited number of licenses to preclude the interference problem).
There was only so much airspace, and the FCC would decide its best use. It would grant limited monopolies. For most of the 20th century the FCC acted as the omnipotent arbiter of who could and who couldn’t use the airwaves. Its decisions were arbitrary. The FCC was lobbied heavily, and economic rents were large. But then something changed. Technology had left the FCC’s archaic decisions in the dust.
The FCC had decided that some portions of the spectrum were so useless that it would let anyone use them. The FCC surmised that no firm or individual would purchase the “worthless” frequencies.
What happened was exactly what Public Choice economists expected. First, the “useless” frequencies became interesting because they were free. Of course, the FCC said you couldn’t interfere with anyone else when using them, but they were still interesting because “free” is good.
What became of some of those frequencies? They became what we now know as Wi-Fi. The FCC thought this was useless radio real estate but Wi-Fi frequencies have turned out to be among the most valuable frequencies on the planet.
The United States decided to follow the advice of Public Choice economists and auction off some of the airwaves. The frequencies that were auctioned to private companies (Sprint, T-Mobile, etc.) brought large amounts of money into the government’s coffers. But, much more importantly, it placed radio spectrum in the hands of private companies. Those companies have a vested interest in using the spectrum economically. The companies have invested large sums of money in research to make the spectrum they own more valuable. We, the consumers, have benefitted by receiving cheaper service, better service and more service.
Would all this have happened if the FCC had continued to allocate frequencies as economic rents?
I suggest that urban real estate, like radio frequencies, has some non-zero value that certain individuals or firms would be willing to purchase — without abatements or government subsidy. This assumes, of course, that local government functions, as previously stated, by confining itself to enforcing the rule of law and providing public goods in the form of roads, bridges, etc.
Where we go from here should be clear. Do we want the government to make the choices and allocate the economic rents as the FCC did for most of the 20th century? Or, do we want to unleash the forces of the market by doing away with abatements and TIFs?
Barry P. Keating, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is professor of economics and business analytics in the Department of Finance at the University of Notre Dame, where he formerly served as chairman. He is a co-author of “Business Forecasting” (McGraw-Hill), now in its Seventh Edition.