AMAZON AND BEYOND: THOUGHTS ON ECONOMIC DEVELOPMENT INCENTIVES

AMAZON AND BEYOND: THOUGHTS ON ECONOMIC DEVELOPMENT INCENTIVES

Last fall, Amazon announced its plans to relocate its headquarters from Seattle, Washington to a new location. Following the announcement, state and local governments have been courting Amazon to select #HQ2 as if they were competing to host the Olympics or a Super Bowl. However, the stakes are much, much higher.  By some estimates, the Amazon headquarters would deliver 50,000 jobs at an average compensation of $100,000 to the host city. Amazon is expected to announce the HQ2 sweepstakes winner in early 2018.

Why Texas is Attractive.  Amazon reportedly received 238 bids, but is seriously considering bids from North Texas and Austin (spearheaded by the Dallas Regional Chamber and Austin Chamber of Commerce respectively). I have not seen the bids from North Texas or Austin. Regardless of the incentives included in the bid, the real strength of the Texas bids are our enterprising people, robust culture, high-quality universities, strong economy, and the stability of our legal and political systems. The fact that Texas does not have a personal income tax is attractive to employers and employees alike. Compared to densely-populated cities on the coasts, commercial and residential real estate in North Texas and Austin is affordable and widely-available. Texas has much going for it, without taking into consideration any special incentives.

Economic Development.  Economic development incentives are typically on-going programs administered by states, municipalities, or development corporations.  The state-level economic development agency in Texas is the Texas Economic Development Corporation. (Readers can learn more about the general incentives and services offered by the Texas Economic Development Corporation and Texas Endowment Fund here.) In simple terms, economic development programs are designed to lure established companies to relocate to a new state, new city or county. As we will see below, the bids for HQ2 from some cities went well beyond the usual parameters of ongoing economic development programs.

The Extravagance of the Competing Bids. The two most notorious bids were from New Jersey and Chicago. New Jersey offered a combined $7 billion in state and city tax incentives.  According to reports, if the bid is accepted, it would be the second-largest economic development package ever offered to a company in the United States. Despite the extravagant bid, the Garden State does not seem to be on Amazon’s radar.

As if to confirm its reputation for political corruption, Chicago (and Illinois) offered to allow Amazon to pocket an estimated $1.32 billion of the personal income taxes paid by its workers annually.  This scheme has been called “income-tax diversion”, because it diverts public tax dollars to private interests.  In addition to receiving diverted public funds, Chicago offered Amazon $1.4 billion in tax credits and $400 in infrastructure spending.

Compared to the bids from New Jersey and Chicago, Chula Vista’s offer of 85 acres (worth $100 million), and deferral of $300 million of property taxes  seems lackluster. But, if a city is so desperate to court a specific business that it must give away so much land, cash and future tax revenue like New Jersey, Chicago and Chula Vista, it’s good a sign that the state and local governments involved have been going down the wrong path on economics, law and regulations for quite some time.

Privilege and Political Risk. The types of economic incentives being offered to Amazon are economic privileges (private benefits or rights) because no similar benefits are being offered to startups, resident companies, or run-of-the-mill non-resident companies. As economic privilege becomes extreme shouldn’t the courted company fear a backlash? That backlash could come in the marketplace through boycotts. Or, future legislators in a nearly insolvent state may seek to renege on the offer of privileges to the courted company. Companies doing business internationally factor in political risk. As it becomes more common for municipalities to default on their loans, and as political swings become more extreme, companies planning future operations would be wise to seek out stable environments.

Anecdotal Experience. I am a corporate and tax attorney by profession. As part of my job, I help clients choose how and where they do business. This includes being part of the decision making on where to locate new facilities in terms of other states, foreign countries, as well as inbound investment from non-resident or foreign companies.

When a company has decided to expand into a new market, the site selection decision will likely be driven by practical economic decisions: what location offers the best economics for getting products or services to customers? Executives will consider supply-chain, logistics and infrastructure including proximity to ports, airports, major highways, rail-lines, etc.  Once the business factors have been considered, governmental incentives may factor into the final site selection.

I occasionally see West Coast companies redomiciling to Texas to avoid the crushing costs of taxes and regulations.  Here, the tail is wagging the dog. Governmental burdens are animating the decision to move.  In these situations, economic development incentives would likely have a greater sway than when a company is growing into new markets to seek new financial opportunities. Because tax and regulatory costs prompted the move, reducing governmental costs will be front of mind.

Thoughts on Economic Development Programs. In a pure laissez faire economy, there would be no economic preferences offered to anyone. This avoids cronyism and favoritism. If we stray from free-market principles, any economic development incentives should be part of on-going programs enacted by democratically-elected lawmakers in advance, rather than ad hoc deals to specific companies. Such programs should have clear, non-discretionary criteria. (More about non-discretionary criteria below).

The legislators and city council enacting such programs should inquire about the cost of incentives, anticipate the increased infrastructure expenditures, estimate the impact on resources, then project the expected return on investment (i.e., the increase to the local economy and resulting increasing in tax receipts). It’s not realistic that lawmakers or their staff will conduct this research themselves. They will rely on input from economic development professionals, lobbyists, think tanks and other experts.

Any major capital expenditures would require a forecast about the long-term viability of the courted company. In an era of disruptive innovations, the odds of betting wrong on a company or existing technology only increase. As technology advances rapidly, some companies’ products will become obsolete. There is risk that the government will make substantial capital expenditures on courting a company that ultimately will not survive long term in the competitive marketplace.

To avoid cronyism, any economic incentive programs should have clear criteria and be non-discretionary. An international example of transparent, non-discretionary incentives is the “Knowledge Development Box” tax incentive offered by the Republic of Ireland. This tax incentive offers a fifty-percent discount on the regular tax rate on income derived from utilizing technology.

The Knowledge Development Box attracts tech companies looking to do business in Europe. Ireland also offers a three-year tax holiday on new companies. These incentives favor tech companies over traditional companies, and new companies over old.  While this is a form of favoritism, these policies offer incentives based on clear criteria rather than backroom negotiations with government officials. While they do “nudge” companies to invest in technology, these sort of tax incentives are available to any company that meets the criteria.

Long Term Policy. Rather than offering economic privileges for private interests, Texas and municipalities should focus on maintaining stable, thriving environment that is attractive to all businesses. The benefits of sound policy should equally be available to startups, established resident corporations, as well as non-resident or international corporations. Texas is blessed with an abundance of natural resources, land and enterprising people. When we pitch for companies to move to Texas, we should lead with those traits, and remind the target company that Texas has a steady track record of being low-cost, and business-friendly.

In the final analysis, Amazon doesn’t even seem to be considering the extravagant bids from Chicago and New Jersey. But, without the details of the Texas bids being released, multiple sources project Dallas and Austin to be among the final contenders. Texas simply is an attractive place to do business. Let’s ensure it remains so for all companies doing business here.

Doug McCullough – Director of Lone Star Policy Institute

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