Local cities have signed an “agreement to make an agreement” on job poaching between jurisdictions. It may be May 2012 or later before the final deal is signed. This is not the first time an agreement has been attempted by local cities, a 2007 pledge slowly eroded because there were no penalties for breaking the pact. Game theory predicts that when an agreement without penalties is signed, the best outcome is to be the first to break the deal (covering your treachery with the smoke of excuses and pleadings that your specific instance was not covered somehow). After the first few breaks of the deal it quickly becomes generally ignored though and all members go back to square one.
This agreement does have some teeth, a city breaking the deal must send 50% of any new payroll tax back to the jurisdiction which was abandoned (for 5 years). That 5 years may be the Achilles heel of the deal, if a company has enough predicted tax revenue in the future, cities may decide that the tax sharing will be an acceptable cost of poaching. Still a better outcome for the abandoned city, but it doesn’t change the game where businesses can hop between local areas in search of the best tax relief.
I wrote a story about tax incentives back in 2003 on my old blog. It holds up well, re-posted after the jump. The highlight of the story is that tax incentives are “picking the winners” by the government, something that the more socialist countries are fond of doing.
“Tax abatements are a hot issue in Grandview right now. There is confusion over how the city should use them, and how the process of negotiation should be done. I think the real problem with abatements is that the average person doesn’t understand the economic theory behind abatements.
I did some research, and was surprised to find that economists, even conservative economists, have many reservations about abatements. The most surprising fact is that abatements are essentially socialistic. Before the city decides to push abatements as a method to attract development, we need to understand the consequences.
The best statements about the economic consequences of abatements I have found is this Ohio committee report that featured Dr. David Ellis, Ph.D. and Fellow for Public Finance, Federation for Community Planning. It was presented to the Ohio Joint Select Committee on State and Local Taxation on September 3, 2002.It’s a long report filled with scholarly economic terms, but it is worth the read. Dr. Ellis’ testimony starts on page 13.
(The link to the report is dead, you might find it somewhere with some searching)
Here is what I took from the report.
1. Local tax abatements distort the playing field for business. If a business receives an abatement and its competitors do not, the government is helping to “pick the winners”. Governments that pick winners are practicing centralized planning, a historically bad practice.
2. Local Tax abatements increases planning and compliance costs on businesses. If businesses must go through complex negotiations with local officials before every move, their costs are increased and their ability to plan is decreased. There are also costs incurred in keeping local governments informed about their compliance with the terms of the abatement.
3. Local abatements allow businesses to blur the connection between taxes paid and services rendered. Although businesses will often complain that they need more employees with high skills and education, they can rationalize that their abatements are only cutting funding from the local schools. The net effect of all abatements is to decrease the funding for all schools, and to provide businesses with lower skilled workers.
4. Businesses that pit local governments against each other in biding for the lowest abatement will always win, and local governments always lose. The highest abatements locally have been for 100% for 10 years, but nothing is preventing an abatement bidding war that could increase the length to 20, 30 or even 50 years.
5. Tax abatements are not subject to the same level of scrutiny and evaluation as directly funded programs to determine if they are running efficiently or having the desired impact.
The recommendation given to the State of Ohio legislators by Dr. Ellis is that the local tax abatements be ended. If the state wants to encourage the preservation of historical buildings, the cleanup of brownfields, or development in economically disadvantaged areas, Ohio should provide grants at the state level. State agencies are in place that can monitor these grants and report on the effectiveness of the programs.
Until the State of Ohio reforms the local abatement process, it is up to each local government to minimize the proliferation of abatements, and negotiate the lowest rates which will still retain companies. The local government must use business skills that allow it to win the best outcome from each negotiation.
If the city wants to have an effective negotiating team it should have a solid knowledge base about taxes. Here are some basic facts about Ohio taxes.
First, it is important to know that the local taxes that can be abated are only 1 or 2% of the cost of staying in business. When a company is looking to relocate, there are many factors which should be of more importance than tax abatements, such as roads & infrastructure (including distance to freeways), features of the building they will be using or renovating, local crime rates, local labor pool, etc. In the case of retail businesses, location is much more important in the final decision.
Second, taxes on the businesses in Ohio have decreased, while local and state taxes on individuals have increased. Ohio does not have business taxes that are higher than the nearby states.
Report of the Committee to Study State and Local Taxes, March 1, 2003. (another dead link)
The following points should be used to produce the best outcome for the city in the abatement process.
1. Companies must be prevented from using “divide and conquer” tactics. When the local school boards, city administrations, and city councils are not united, businesses can play them against each other. A single government committee should engage the process of negotiating abatements, and the final abatement agreement should be submitted for votes by school boards and local government only after that process is completed.
2. Local government should have abatement processes and guidelines in writing so that companies know what to expect before they start the abatement process.
3. Local government must learn to say no. When companies learn that every preceding negotiation has ended with an agreement that was highly favorable to the business, they naturally develop expectations that abatements are a service that the government provides to all. Local governments must make tough bargains, and occasionally they must walk away from the table. They need to communicate to the local community that a failed abatement agreement is a normal part of the process and is a sign that the government is doing its job. ”