When I read that Wichita had invested nearly $60 million in its Spirit AeroSystems plant, I thought I must have been napping during a city council meeting. Instead, the lede of the story in the Tulsa World newspaper was a misstatement of the mechanism of Industrial Revenue Bonds (IRBs).
The News reported “News that the city of Wichita is moving to invest nearly $60 million in its Spirit AeroSystems plant has Vision2 backers warning that Tulsa’s aerospace jobs are at risk of poaching by other cities.”
A Tulsa television news report offered similar reporting: “… after the City of Wichita, Kansas offered roughly $60 million in incentives to try and steal Spirit Aerosystems away from Tulsa.”
When news stories cover IRBs, the stories usually focus on the amount of the bonds, as in these two examples. That’s unfortunate, as the amount of the bonds is really a minor component of the story.
You see this misunderstanding revealed in comments left to newspaper articles reporting the issuance of IRBs, where comment writers complain that the city shouldn’t be in the business of lending companies money.
This confusion hides the reason why IRB transactions take place, which is tax avoidance. That’s the real story of Industrial Revenue Bonds: Companies escape paying the property and sales taxes that you and I — as well as most business firms — must pay.
Reading the city council agenda packet regarding the IRB issue tells the story. The city is not lending Spirit money. In fact, no one is, according to the city document: “Spirit AeroSystems, Inc. intends to purchase the bonds itself, through direct placement, and the bonds will not be reoffered for sale to the public.”
Also, the city has no obligation to pay the bondholders should Spirit default. This is a moot point in this case, as the issue of the bonds is also the buyer. But this is the case with all IRBs.
It’s not uncommon for the issuing company to buy the bonds. So why issue the bonds? The agenda packet has the answer: “The bond financed property will be eligible for sales tax exemption and property tax exemption for a term of ten years, subject to fulfillment of the conditions of the City’s public incentives policy.”
City documents didn’t give the amount of tax Spirit will avoid paying, so we’re left to surmise. Bonds could be issued up to $59.5 million. Taxable business property of that value would generate an annual tax bill of around $1.8 million per year, but Spirit would not pay that for up to ten years. If all the purchased property was subject to sales tax, that one-time tax exemption would be $4.3 million. These are the upper bounds of the tax savings Spirit Aerosystems may receive. Its actual savings will probably be lower, but still substantial.
These numbers are the economic benefit of the bonds to Spirit, and the opportunity cost of the bonds to taxing jurisdictions. The $60 million “investment” or “incentive” reported by two Tulsa news sources is incorrect.
Industrial Revenue Bonds, a confusing program
IRBs are a confusing economic development program. It sounds like a loan from the city or state, but it’s not. The purpose is to convey tax avoidance.
Here’s language from the Wichita ordinance that was passed to implement the bonds: “The Bonds, together with the interest thereon, are not general obligations of the City, but are special obligations payable (except to the extent paid out of moneys attributable to the proceeds derived from the sale of the Bonds or to the income from the temporary investment thereof) solely from the lease payments under the Lease, and the Bond Fund and other moneys held by the Trustee, as provided in the Indenture. Neither the credit nor the taxing power of the State of Kansas or of any political subdivision of such State is pledged to the payment of the principal of the Bonds and premium, if any, and interest thereon or other costs incident thereto.”
So no governmental body has obligations to pay the bondholders in case of default. But this language hints at another complicating factor of IRBs: The city actually owns the property purchased with the bond proceeds, and leases it to Spirit. Here’s the preamble of the ordinance: “An ordinance approving and authorizing the execution of a lease agreement between Spirit Aerosystems, Inc. and the City of Wichita, Kansas.”
Other language in the ordinance is “WHEREAS, the Company will acquire a leasehold interest in the Project from the City pursuant to said Lease Agreement.” There’s other language detailing the lease.
We create this imaginary lease agreement — and that’s what it is, as it doesn’t have the same purpose and economic meaning as most leases — for what purpose? Just so that certain companies can avoid paying taxes.
The city does have another program that allows it to exempt these taxes under some circumstances without having to issue bonds. In this case the goal of the program is laid clear: tax avoidance.
IRBs are a confusing program that obfuscates the actual economic transaction. That’s not good public policy, whether or not you agree with the concept of selective tax abatements as economic development.
Similarly, a principle of good tax policy is that those in similar situations should face the same laws. IRBs are contrary to this.
While we can understand that citizens — with their busy lives — may not be informed or concerned about the complex workings of IRBs, we should expect more from our elected (and paid) officials. But we find often they are not informed.
As an example, in 2004 the Wichita Eagle reported: “In July, the council approved industrial revenue bond financing and a $1.7 million property tax abatement for Genesis Health Clubs. Council members later said they didn’t realize they had also approved a sales-tax break.” (Kolb goal : Full facts in future city deals, September 26, 2004)
Here we see Wichita City Council members not aware of the basic mechanism of a major city program that is frequently used. This is in spite of an informative city web page devoted to IRBs which prominently states: “Generally, property and services acquired with the proceeds of IRBs are eligible for sales tax exemption.”
Yes, that page was active in 2004.
Lol @ Bob. You don’t even understand the basics of IRB financing and yet criticize the city council.
Pot meet kettle!
Please explain for us where I am wrong.
I agree with Bob’s explanation of how IRB’s work. They are only for tax avoidance. No risk to the city. It’s been explained that the lease is additional security for the city, but why if there’s no risk.
Instead of the state exempting all new construction from sales tax, like residential repair, a project requires a city approval to qualify for the exemption. Like the IRB’s.
IRB financing is a program to allow long-term at low interest rates. The issuing governmental entity is merely the conduit for the financing and provides no backing or security on the bonds. Typically the cities as an incentive also grant tax exemptions for the real property. They don’t have to and it’s not a requirement of the state statutes.
The main advantage on IRB financing is the long-term nature of the fixed debt obligation. Anyone who does commercial financing knows that 20-year debt finacing in the conventional markets is virtually unheard of.
The Kansas Dept. of Commerce website explains the mechanics of IRB financing fairly well but not necessarily the underlying rationale as to why IRB financing was created.
Or this explanation from Smart Money: