To Subsidize or Not to Subsidize - Highlights from MCFE's 2013 Annual Meeting

Are business tax incentives and targeted subsidies good policy?  Distinguished government and business representatives examined the issues at our 87th Annual Meeting of Members.  From our September-October 2013 edition of Fiscal Focus.

Over 120 members and distinguished guests attended our 87th Annual Meeting of Members at the St.  Paul River Centre on October 2 – but the first such meeting as the Minnesota Center for Fiscal Excellence.  Our policy session this year focused on the complicated intersection of good tax policy, tax incentives, and economic development; a topic in the news and one likely to be a mainstay of legislative debate for years to come.

Commissioner's Update

Perhaps in recognition that this year’s legislative session may have left a bitter aftertaste in the mouths of some MCFE members, Commissioner Myron Frans led off the policy session with a presentation designed for persuasion – heavily focused on discussing the rationale and justification behind the controversial tax and fiscal policies enacted this year. He reiterated the two themes driving this policy agenda – a “gimmick free” structurally balanced budget and investment in public goods that Governor Dayton believes have needed attention and are critical to long-term economic growth.

Commissioner Frans provided an overview of the chronic budget challenges the state has faced over the past decade and discussed the policy concerns prompting the spending increases in E-12 education, higher education, and economic development. With respect to the Revenue Department itself, the Commissioner highlighted the new upgraded web presence and discussed ongoing efforts to improve agency responsiveness and information dissemination. Business e-filing, education and outreach to newly formed businesses, and stakeholder conference calls to discuss and clarify tax law changes have been three priorities.

He concluded his presentation with a synopsis of the tax changes enacted this year placing, not surprisingly, a strong emphasis on the resulting tax fairness and progressivity improvements. Although, he noted, Minnesota’s recent economic performance relative to the rest of the nation has been quite stellar, the focus on economic development must continue and job creation remains the number one priority of the administration.

The challenge of meeting those jobs expectations provided a good segue into the featured panel on business incentives, tax policy, and economic development realities. A distinguished group of government and business leaders moderated by MPR’s economic correspondent Chris Farrell engaged in a wide-ranging discussion of the practice, politics, and policy issues surrounding the use of tax and other forms of business incentives. Panel participants were Representative Ann Lenczewski, DEED Commissioner Katie Clark Sieben, Greater MSP executive David Griggs, Minnesota Chamber of Commerce senior vice president Bill Blazar, and former state economist Tom Stinson.

The Proponents

Two panelists argued strongly that, like it or not, subsidies and targeted tax incentives are a necessity of today’s economic development realities. Commissioner Sieben and David Griggs both noted that good economic fundamentals – workforce quality, public infrastructure, etc. – remain as necessary as ever but are often insufficient in today’s intensely competitive economic development environment.

Mr. Griggs emphasized the idea that site selection is a process of exclusion. Great fundamentals are, without question, necessary to keep you in play – a quality workforce, good transportation systems, and all the other basics are a requirement. But the process of actually “winning” new companies increasingly requires at least some type of financial incentive and having these available is “needed and necessary to compete.”

Both argued that Minnesota’s high quality fundamentals help reduce the need for and reliance on incentives. Both cited examples where Minnesota was chosen over another state offering incentive packages many times larger because of the advantage Minnesota offered with respect to workforce and related issues. And both asserted that Minnesota has embarked both modestly and pragmatically into these waters with respect to the size of the incentives offered, and how they are used. Commissioner Sieben noted Minnesota’s programs are a very small fraction of the scale and cost of programs found in many other states. Mr. Griggs emphasized the strategic nature Minnesota uses when employing these programs. Unlike other states, he argued, “we don’t play the zero sum game, we are smarter than that.” Minnesota focuses its incentive spending on foreign direct investment, new companies, expanding companies, and firms with skills complementary to Minnesota’s economic base. Other states, he said, use their financial incentives to chase anything that may move.

With respect to accountability issues, both noted that their respective organizations emphasize performance measures and tracking returns on investment. According to Commissioner Sieben, each dollar invested through Minnesota Investment Fund leverages $33 in private investment. Similarly, Greater MSP’s board has established a minimum 10:1 return on dollars invested and according to Mr. Griggs current performance is tracking more like 40:1. Commissioner Sieben also noted many of the DEED incentive programs are designed to include both clawback and pay for performance provisions.

Some critics of business incentives and subsidies have argued they should only be offered if various social and equity outcomes are an additional condition of their provision – such as living wage requirements, physical siting in economically depressed areas, or minority hiring provisions. Mr. Griggs adamantly dismissed such policy ideas noting he has never dealt with a business seeking more regulations on how to access money.

The Skeptics

In contrast, Representative Lenczewski, Bill Blazar, and Dr. Tom Stinson expressed considerably greater reservations and concerns regarding the use of tax incentives and targeted subsidies. Their objections arose out of both principle and practice.

Commenting that such policies may be good politics but poor policy and economics, Representative Lenczewski criticized both the distortion of markets and the major political problems of expectation and dependency these policies create over time. Both Representative Lenczewski and Blazar spoke to the implicit fairness problems such policies embody, noting that while the vast majority of Minnesota’s businesses do not benefit from these policies, they still bear much of the price tag associated with them. Mr. Blazar extended his critique to include the business taxation which made up a significant share of the $2.3 billion raised last session, commenting that “98% feel all the pain but get nothing from the benefit.”

Dr. Stinson commented on the timeless nature of this debate and provided an historical perspective, noting that in colonial days Alexander Hamilton’s business was wooed to New Jersey by such incentives. He reiterated the concerns of principle expressed by other panelists, but said absent federal intervention to rein in the use of incentives – an approach advocated by most economists – they will continue to be used. As a result he offered a seven-point plan to keep their proliferation under some semblance of control:

• Make sure benefits exceed costs
• Apply a “but for” test to all proposals
• Indentify the market failure the incentive/ subsidy is intended to address
• Put a sunset provision on all programs
• Provide for full public disclosure of subsidies and impacts
• Create legally binding contracts with clawback provisions based on performance
• Only award incentives if other firms are not put at a disadvantage

The panelists also expressed concerns over design issues. Representative Lenczewski emphasized legislators are simply not equipped to make these deals or be in a position to provide the best protection for taxpayer interests. Noting how easy it is for legislators “to get rolled,” Representative Lenczewski cited the Mayo Destination Medical Center project as one example of the very lengthy process of proposal and counterproposal that was needed to arrive at a truly acceptable result. There are also intangible costs. Arriving at an acceptable final agreement requires extraordinary amounts of legislative staff time and effort (who, according to the House Tax chair, are the unsung heroes of these things) which creates a major opportunity cost for the legislative process and other important matters on policymakers’ agenda.

What should be the focus of our economic development efforts? All three skeptics expressed concern about the ability of tax and incentive programs to distract us from the things that really matter – the foundational strengths of Minnesota’s economy, such as a highly skilled and educated workforce. Dr. Stinson emphasized that demographic challenges are creating the need for world class adult education. Rep. Lenczewski highlighted the Governor’s significant investments in E-12 and higher education. Mr. Blazar concurred with the need to focus on matters of true long-term strategic interest, but also expressed deep concerns about the increasing false equivalency of government spending and results. For example, at the same time more money was pumped into the E-12 education system, education standards required for graduation were repealed. Mr. Blazar argued that investments in ways to get better results and more for the money is just as important, if not more so, than the spending itself.

The Skeptics

In his luncheon address former National Tax Association and Federation of Tax Administrators president Billy Hamilton claimed agnosticism on this issue, joking that he has had to alter his perspective on this topic many times through the course of his long career in public finance depending on the organizational hat he was wearing. But his agnosticism is really rooted in a sense of political pragmatism.

He asserted that there are two fundamental truths regarding targeted subsidies and business tax incentives. The first is that over fifty years of study, no one has proved any lasting economic benefit from their use. Small project successes may be realized but often at considerable expense to state coffers. More importantly, their economic consequence means absolutely nothing relative to the scale of state economies. Meanwhile, attracting footloose firms means higher taxes for everyone else.

The second fundamental truth is that the above point simply doesn’t matter and never will. He said “angels could descend from on high” proclaiming them wasteful, shortsighted and mistaken policy and it wouldn’t matter – elected officials will continue to pursue them. Visible, high profile, and tangible results are absolutely irresistible to elected officials. Plus, “it makes them feel good.”

Complimenting the state based on the content of the panel discussion, Hamilton reflected that said Minnesota probably does a good a job as any state in achieving a balance. He argued it would likely “shock Minnesotans to the core” to witness the practices occurring in other states. He affirmed both Dr. Stinson’s policy recommendations and the need to focus on public spending critical to long-term economic growth. He noted that while the economic success and performance of his home state of Texas has received considerable attention, health, transportation, education, and water issues are presenting long term risks to his state’s economy.

So are business incentives and sound tax policy friends, enemies, or a difficult marriage? The answer appears to be all three. At their very best, carefully designed programs adhering to the principles espoused in the panel can complement economic development efforts while keeping distortions and cost to a minimum. At their very worst, they can be expensive, transitory, wasteful giveaways yielding nothing with respect to lasting economic gain. In reality and practice, they will have elements of the best and the worst, creating underlying tension and remaining a difficult political marriage for many years to come.