Natalie Bright and Marlee Carpenter of Bright and Carpenter Consulting briefed members and guests of the Wichita Pachyderm Club on the results of the 2015 session of the Kansas Legislature, and what to look for in next year’s session and elections. December 4, 2015.
The accompanying visual presentation may be viewed here.
In this episode of WichitaLiberty.TV: A look at Wichita community outreach and communications, rewriting city council history, and entrepreneurship. View below, or click here to view at YouTube. Episode 102, broadcast December 6, 2015.
Shownotes
Wichita considers three tax abatements, in one case forcing an “investment” on others that it itself would not accept.
This week the Wichita City Council will consider three tax abatements to companies in the aerospace business. Two are very large companies, and one is in the small business category.
In two cases the tax abatements are implemented through industrial revenue bonds. Under this program the city is not lending money. Instead, the program is a vehicle, created by under Kansas law, for companies to avoid paying property tax. In some cases companies may also avoid paying sales tax.
In another case the property tax abatement is conveyed through the city’s Economic Development Tax Exemption (“EDX”) program, which allows the city to forgive the payment of property taxes. In many instances, the issuance of Industrial Revenue Bonds is required by law in order to achieve tax forbearance. The EDX program does away with the often meaningless issuance of bonds, and lets the city implement, in a streamlined fashion, the primary economic goal: Granting permission to skip the payment of property taxes.
The goal of the industrial revenue bonds, however, is often obscured by news media and the city itself. For example, in the agenda material for the Cessna IRBs, the city states “Bond proceeds will be utilized to finance capital investment in the Wichita facilities.”
But later in the same document, we see “The IRBs will be purchased by Cessna and will not be offered to the public.” So the IRBs — the bonds the city is authorizing — aren’t really financing anything. By buying the bonds itself, Cessna is self-financing the purchases or obtaining the funds in some other way. The IRBs are merely a device to grant tax abatements. Nothing more than that — except that the bond program obfuscates the true economic meaning of the transaction, adds costs to the applicant company, and adds cost to the city (offset to some degree by fees paid by the applicant company).
Regardless of the cost and hassle to Cessna, the program has a payoff. City documents state that Cessna could save as much as $317,357 per year in property taxes.
For the Bombardier Learjet IRBs, the city tells us that “Bond-financed purchases are also exempt from state and local sales taxes.” The amount of abated taxes is not given.
For Perfekta, an aerospace supplier, the city is using the EDX program to convey a property tax abatement, with the estimated value of the tax exemption in the first full year being approximately $110,792, according to the agenda packet.
In this case, the city did not award a 100 percent tax abatement. This is due to the city’s policy of requiring a benefit-cost ratio of 1.3 to one, although there are exceptions the city may use. In this case, the city adjusted the amount of tax abatement down until the 1.3 benchmark was achieved, as described in city documents: “To achieve the ratio of benefits to costs of at least 1.3 to 1.0 as required in the City/County Economic Development Policy, the percentage abatement should be reduced to an 89% tax exemption on a five-plus-five year basis.”
The benefit-cost ratio is calculated by the Center for Economic Development and Business Research (CEDBR) at Wichita State University based on data supplied by the applicant company and the city. The rationale behind these calculations is a matter of debate. Even if valid, calculating the ratio with such precision is folly, reminding us of the old saw “Economists use a decimal point to remind us they have a sense of humor.”
Of note, while the city wants to “earn” a 1.3 ratio of benefits to costs, it forces a lower ratio on two overlapping jurisdiction, as shown in city documents:
City of Wichita 1.34 to 1
City of Wichita General Fund 1.30 to 1
Sedgwick County 1.24 to 1
USD 259 1.17 to 1
State of Kansas 7.94 to 1
The county and school district have no choice but to accept the decision made by the city and accept a “return” lower than the city would accept for itself.
The city presents a benefit-cost ratio to illustrate that by giving up some property taxes, it gains even more tax revenue from other sources. But a positive benefit-cost ratio is not remarkable. Economic activity generally spawns more economic activity, which government then taxes. The question is: Did the city, county, school district, and state need to give up tax revenue in order to make these investments possible?
Part of the cost of these companies’ investment, along with the accompanying risk, is spread to a class of business firms that can’t afford additional cost and risk. These are young startup firms, the entrepreneurial firms that we need to nurture in order to have real and sustainable economic growth and jobs. But we can’t identify which firms will be successful. So we need an economic development strategy that creates an environment where these young entrepreneurial firms have the greatest chance to survive. The action the Wichita city council is considering this week works against entrepreneurial firms. (See Kansas economic growth policy should embrace dynamism and How to grow the Kansas economy.)
A major reason why these tax abatements are harmful to the Wichita economy is its strangling effect on entrepreneurship and young companies. As these companies and others escape paying taxes, others have to pay. This increases the burden of the cost of government on everyone else — in particular on the companies we need to nurture.
There’s plenty of evidence that entrepreneurship, in particular young business firms, are the key to economic growth. But Wichita’s economic development policies, as evidenced by this action, are definitely stacked against the entrepreneur. As Wichita props up its established industries, it makes it more difficult for young firms to thrive. Wichita relies on targeted investment in our future. Our elected officials and bureaucrats believe they have the ability to select which companies are worthy of public investment, and which are not. It’s a form of centralized planning by government that shapes the future direction of the Wichita economy.
These targeted economic development efforts fail for several reasons. First is the knowledge problem, in that government simply does not know which companies are worthy of public investment. This lack of knowledge, however, does not stop governments from creating policies for the awarding of incentives. This “active investor” approach to economic development is what has led to companies receiving grants or escaping hundreds of millions in taxes — taxes that others have to pay. That has a harmful effect on other business, both existing and those that wish to form. Young entrepreneurial companies are particularly vulnerable.
Professor Art Hall of the Center for Applied Economics at the Kansas University School of Business is critical of this approach to economic development. In his paper Embracing Dynamism: The Next Phase in Kansas Economic Development Policy, Hall quotes Alan Peters and Peter Fisher: “The most fundamental problem is that many public officials appear to believe that they can influence the course of their state and local economies through incentives and subsidies to a degree far beyond anything supported by even the most optimistic evidence. We need to begin by lowering expectations about their ability to micro-manage economic growth and making the case for a more sensible view of the role of government — providing foundations for growth through sound fiscal practices, quality public infrastructure, and good education systems — and then letting the economy take care of itself.”
In the same paper, Hall writes this regarding “benchmarking” — the bidding wars for large employers: “Kansas can break out of the benchmarking race by developing a strategy built on embracing dynamism. Such a strategy, far from losing opportunity, can distinguish itself by building unique capabilities that create a different mix of value that can enhance the probability of long-term economic success through enhanced opportunity. Embracing dynamism can change how Kansas plays the game.”
In making his argument, Hall cites research on the futility of chasing large employers as an economic development strategy: “Large-employer businesses have no measurable net economic effect on local economies when properly measured. To quote from the most comprehensive study: ‘The primary finding is that the location of a large firm has no measurable net economic effect on local economies when the entire dynamic of location effects is taken into account. Thus, the siting of large firms that are the target of aggressive recruitment efforts fails to create positive private sector gains and likely does not generate significant public revenue gains either.’”
(For a summary of the peer-reviewed academic research that examines the local impact of targeted tax incentives from an empirical point of view, see Research on economic development incentives. A sample finding is “General fiscal policy found to be mildly effective, while targeted incentives reduced economic performance (as measured by per capita income).”)
There is also substantial research that is it young firms — distinguished from small business in general — that are the engine of economic growth for the future. We can’t detect which of the young firms will blossom into major success — or even small-scale successes. The only way to nurture them is through economic policies that all companies can benefit from. Reducing tax rates for everyone is an example of such a policy. Abating taxes for specific companies through programs like the Wichita city council is considering this week is an example of precisely the wrong policy.
In explaining the importance of dynamism, Hall wrote: “Generally speaking, dynamism represents persistent, annual change in about one-third of Kansas jobs. Job creation may be a key goal of economic development policy but job creation is a residual economic outcome of business dynamism. The policy challenge centers on promoting dynamism by establishing a business environment that induces business birth and expansion without bias related to the size or type of business.”
We need to move away from economic development based on this active investor approach, especially the policies that prop up our established companies to the detriment of dynamism. We need to advocate for policies — at Wichita City Hall, at the Sedgwick County Commission, and at the Kansas Statehouse — that lead to sustainable economic development. We need political leaders who have the wisdom to realize this, and the courage to act appropriately. Which is to say, to not act in most circumstances.
A company that has a taxpayer-guaranteed loan may be entering bankruptcy. Will taxpayers have to pay?
(Updated November 30) Spanish energy giant Abengoa has taken preliminary steps that could lead to bankruptcy filing.
Of relevance to Kansas — and the country at large — is the Abengoa cellulosic ethanol plant near Hugoton. That plant received a $132.4 million loan guarantee from the United States government under the same program that benefited Solyndra. That company cost taxpayers over $500 million when it defaulted on its taxpayer-guaranteed loan.
Does a bankruptcy filing by Abengoa place U.S. taxpayers on the hook for the company’s guaranteed loan? If so, are taxpayers liable for the entire $132.4 million or some smaller portion?
The answer is this: We don’t know. I’ve asked for, and have received the loan guarantee agreement. It’s unclear to me what would happen if Abengoa entered bankruptcy.
Following, reporting from the Wall Street Journal. It mentions “debt-fueled expansion,” some of which is a liability of the U.S. taxpayer.
Spain’s Abengoa Files for Creditor Protection
The company’s debt-fueled expansion in the boom years is handicapping growth today
MADRID — Spanish renewable energy and engineering firm Abengoa SA said on Wednesday that it is filing for preliminary creditor protection, an initial step that could lead to the largest bankruptcy case in the country’s history.
The potential demise of Abengoa is an extreme example of a Spanish company whose debt-fueled expansion during the country’s boom years has handicapped its ambitions for growth today.
The company is one of the world’s top builders of power lines transporting energy across Latin America and a top engineering and construction business, making massive renewable-energy power plants in places from Kansas to the U.K.
Continue reading at Wall Street Journal.
In this episode of WichitaLiberty.TV: Congressman Mike Pompeo talks about the Middle East, politics in Washington, and domestic issues. View below, or click here to view in high definition at YouTube. Episode 101, broadcast November 29, 2015.
Shownotes
By David Dorsey, Kansas Policy Institute
The Kansas at-risk program, which spent $3.6 billion over the past 23 years, failed its mission to improve the performance of the very students it was designed to serve. Achievement gaps in academic performance (in this case the difference between low-income and not-low-income students) are universal, significant and persistent despite the incredible growth in funding, in particular the increases since 2005.
Four basic reasons the program failed in its mission are: dollars were not targeted exclusively to at-risk students, some funds were actually targeted directly to non-at-risk students, school districts were not held accountable, and scant information about the at-risk program was made available to the legislature and the public.
Despite the shortcomings, an at-risk component should be included in the new education finance law, with these fundamental changes: at-risk students must be clearly identified and dollars targeted directly to them, the method of funding the program should be changed, and school districts must be held accountable to the public.
It is important to note that there is no recommendation for reducing the amount of funding for at-risk students, but a call for a more effective use of the dollars.
Eric Hanushek, Senior Fellow at the Hoover Institution of Stanford University and education policy authority, made these concurring remarks:
This report on at-risk funding in Kansas accurately identifies what is a national problem. While we directly fund a number of programs to improve the education of at-risk students, we never follow-up to see that the money is used effectively. If we are going to solve this problem of achievement gaps, we need to fund programs to support at-risk students but to hold schools accountable for results.
As the Kansas legislature crafts a new K-12 finance law, it is the perfect opportunity to overhaul the approach in addressing inequities in achievement based on economic status. It’s time to put all Kansas students first.
Congressman Mike Pompeo, fourth district of Kansas, offered his perspective on recent happenings in Europe, the Middle East and Washington, D.C., at a luncheon gathering of the Wichita Pachyderm Club November 20, 2015. View below, or click here to view in high definition at YouTube. Videography by Paul Soutar.
When Kansas cities grant economic development incentives, they may also unilaterally take action that affects overlapping jurisdictions such as counties, school districts, and the state itself. The legislature should end this.
When Kansas cities create tax increment financing (TIF) districts, the overlapping county and school district(s) have an opportunity to veto its creation.
But for some other forms of incentives, such as tax increment financing district redevelopment plans, property tax abatements, and sales tax abatements, overlapping jurisdictions have no ability to object. There seems to be no rational basis for not giving these jurisdictions a chance to object to the erosion of their tax base.
This is especially important for school districts, as they are often the largest tax consumer. As an example, when the City of Wichita offered tax abatements to a company in June 2014, 47 percent of the abated taxes would have gone to the Wichita school district. But the school district did not participate in this decision. State law gave it no voice.
Supporters of economic development incentives say that the school district benefits from the incentives. The argument is that even though the district gives up some tax revenue now, it will get more in the future. This is the basis for the benefit-cost ratios Wichita uses to justify incentives. For itself, the City of Wichita requires a benefit-cost ratio of 1.3 to one or better, although there are many loopholes the city can use to grant incentives when this threshold is not met. For the June project, city documents reported these benefit-cost ratios for two overlapping jurisdictions:
Sedgwick County 1.18 to one
USD 259 1.00 to one
In this case, the city forced a benefit-cost ratio on the county that the city would not accept for itself, unless it uses a loophole. For the school district, the net benefit is zero.
The Kansas Legislature should look at ways to make sure that overlapping jurisdictions are not harmed when economic development incentives are granted by cities. The best way would be to require formal approval of the incentives by counties, school districts, and any other affected jurisdictions.
In June 2014 the City of Wichita granted tax abatements for a new warehouse. City documents gave the benefit-cost ratios for the city and overlapping jurisdictions:
City of Wichita General Fund 1.30 to one
Sedgwick County 1.18 to one
USD 259 1.00 to one
State of Kansas 12.11 to one
It is not known whether these ratios include the sales tax forgiveness.
While the City of Wichita insists that projects show a benefit-cost ratio of 1.3 to one or better (although there are many exceptions), it doesn’t apply that standard for overlapping jurisdictions. Here, Sedgwick County experiences a benefit-cost ratio of 1.18 to one, and the Wichita school district (USD 259) 1.00 to one. These two governmental bodies have no input on the decision the city is making on their behalf. The school district’s share of the forgiven taxes is 47.4 percent.
In November 2014 a project had these dollar amounts of property tax abatement shared among the taxing jurisdictions in these estimated amounts, according to city documents:
City $81,272
State $3,750
County $73,442
USD 259 $143,038
The listing of USD 259, the Wichita public school district, is likely an oversight by the city, as the subject properties lie in the Derby school district. This is evident when the benefit-cost ratios are listed:
City of Wichita 1.98 to one
General Fund 1.78 to one
Debt Service 2.34 to one
Sedgwick County 1.54 to one
U.S.D. 260 1.00 to one (Derby school district)
State of Kansas 28.23 to one
Note that the ratio for the Derby school district is 1.00 to one, far below what the city requires for projects it considers for participation. That is, unless it uses a loophole.
A Wichita developer seeks to have taxpayers fund a large portion of his development costs, using a wasteful government program of dubious value.
When you hear of a program titled “historic preservation tax credits” you might find yourself in agreement. Preserving history: Who can be against that? And tax credits: Aren’t those just technical adjustments on someone’s tax form?
The Colorado-Derby Building at 201 N Water Street in Wichita has been nominated for placement on the Register of Historic Kansas Places. It’s a nondescript building which currently houses administrative offices for the Wichita public school district and is known by a different name. Still, it is eligible for placement on the register for being an “example of this private investment trend,” that being the building of office buildings midcentury. A laudable accomplishment, but hardly notable.
The real reason for seeking placement on the register of historic places is money. By using historic preservation tax credits the developer of this building can get taxpayers to pay for much of the costs of rehabilitation. Almost half, which will be millions in this case.
Under the program this building is entering, its owners will receive 25 percent of rehabilitation expenses. The federal government provides tax credits of 20 percent. It’s likely that the owners of this building will also seek these credits.
So with both tax credit programs, 45 percent of the cost of rehabilitating this building could be paid for by taxpayers. And, given the history of the developer, it’s likely he will find other ways to get taxpayers to pay for even more.
Tax credits may be a mystery to many, but there is no doubt as to their harmful effect on state and federal budgets. When using tax credits, the government, conceptually, issues a slip of paper that says something like “The holder of this document may submit it instead of $500,000 when making a tax payment.” So instead of paying taxes with actual money, the holder of the credit pays with, well, a slip of paper worth nothing to the government treasury.
This is a direct cost to the government, according to both reason and the Kansas Division of Legislative Post Audit. Last year, after conducting an audit of Kansas tax credit programs, auditors explained: “Tax credits, which the government offers to try to induce certain actions by the taxpayer, reduce income tax revenues because they are subtracted directly from the amount of taxes due.” (emphasis added)
The confusing nature of tax credits leads citizens to believe that they have no cost to the state or federal government. But tax credits are equivalent to government spending. The problem is that by mixing spending programs with taxation, some are lead to believe that tax credits are not cash handouts. But not everyone falls for this seductive trap. In an article in Cato Institutes’s Regulation magazine, Edward D. Kleinbard explains:
Specialists term these synthetic government spending programs “tax expenditures.” Tax expenditures are really spending programs, not tax rollbacks, because the missing tax revenues must be financed by more taxes on somebody else. … Tax expenditures dissolve the boundaries between government revenues and government spending. They reduce both the coherence of the tax law and our ability to conceptualize the very size and activities of our government. (The Hidden Hand of Government Spending, Fall 2010)
The use of tax credits to pay for economic development incentives leads many to believe that what government is doing is not a direct subsidy or payment. In order to clear things up, perhaps we should require that government write checks instead of issuing credits.
Back to Kansas: The audit of the historic preservation tax credits program found that in 2001, when the program was started, the anticipated cost to the state was about $1 million per year. By 2007, the actual cost to the state was reported at almost $8.5 million.
Further, the audit found what many already knew: tax credit aren’t an efficient way of transferring subsidy to developers. Most of the time, the developers sell the credits to someone else at a discount, as the audit explains: “The Historic Preservation Tax Credit isn’t cost-effective. That credit works differently than the other three because the amount of money a historic preservation project receives from the credit is dependent upon the amount of money it’s sold for. Our review showed that, on average, when Historic Preservation Credits were transferred to generate money for a project, they only generated 85 cents for the project for every dollar of potential tax revenue the State gave up.”
It would be more efficient for everyone if the state would simply write checks to the developers instead of issuing tax credits. But then the actual economic meaning of the transaction would be laid bare for all to see.
Then, what qualifies as historic can change as political conditions require. Earlier this year the Wichita city council reversed a decision by the Historic Preservation Board and allowed a property owner to proceed with the demolition of three formerly historic buildings in southern downtown Wichita.
The historic preservation tax credit program is a government handout mechanism we no longer need. Today, most of the money goes to wealthy developers or corporations that can afford to redevelop downtown hotels and lofts with their own money — instead of asking low-income families to pay sales tax on their groceries to fund their tax credits.
Material from the Kansas State Historical Society
Nomination for listing on Register of Historic Kansas Places
Colorado-Derby Building – 201 N Water St., Wichita, Sedgwick County
Constructed in 1959-1960, the nine-story Colorado-Derby Building is an early example of a Modern Movement speculative office tower erected within a pattern of development that shaped Wichita’s downtown at midcentury. New buildings erected as icons on the skyline were intended to refresh, modernize, and revitalize the downtown core through public and private investment in civic and commercial improvements. Frank and Harvey Ablah recognized the onset of this trend and constructed the Colorado-Derby Building to provide speculative office space, redeveloping the site of the Ablah Hotel Supply Company. Named for its largest and most prominent tenant, the Colorado-Derby Building was fully occupied when it opened in 1960 and maintained high occupancy rates over the following decade. The construction and subsequent occupancy of this building illustrates the continuing importance of manufacturing industries to the economy of Wichita at midcentury and the ability of these industries to contribute to the economic and physical revitalization of downtown. The blocks immediately surrounding the building continued to develop in a similar fashion over the following decade with large-scale modern buildings and parking lots replacing smaller commercial and industrial buildings built a half-century earlier. All of this development activity culminated in a formal Urban Renewal project utilizing federal funds in the late 1960s. In Wichita, private investment focused on providing office space for industrial companies, rather than public funding initiated the revitalization that transformed downtown. The Colorado-Derby Building is nominated under Criterion A an important early example of this private investment trend.