Incentive program ignores ‘One Lesson’

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Recording an episode of WichitaLiberty.TV on the topic of “Economics in One Lesson” reminded me of a story I reported last year. The lesson is “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” A program implemented last year in Wichita provides examples of how governments ignore this lesson.

A document released by the City of Wichita casts strong doubt on the wisdom of a new home property tax rebate program. The document also lets us know that city staff are not being entirely honest with the citizens of Wichita.

The new home tax rebate program, according to city documents prepared for the February 14, 2012 city council meeting, provides free Wichita city property taxes to buyers of qualifying new homes: “To promote additional new home construction and new home ownership, the City of Wichita, after extensive coordination and discussion with WABA, is proposing a New HOME (New Home Ownership Made Easy) Program. The program will provide a 5 year rebate of City property taxes for eligible property. To be eligible, property must be in a participating development, with all taxes through 2010 (general and special assessment) current in the development. In addition, to be eligible, the special assessment and general taxes must be paid current at the date of sale and closing of a property.”

WABA is The Wichita Area Builders Association , a trade association for home builders. The document recently released is a study or analysis of the program dated February 1 from Wichita State University Center for Economic Development and Business Research.

During the period of the tax rebate program, the study estimates that 787 homes would be built and sold even if there was no rebate program. It is assumed that 1,000 homes would be sold during that period with the rebate program, but that is not certain.

Following is an excerpt from a table that presents the results of analysis. The benefits and costs are to the City of Wichita General Fund. Benefits are, according to the study, “sales tax revenues, from construction worker spending and construction material purchases, and property tax revenues.” The costs are the lost revenue due to the tax rebates.

                   No Incentives    Incentives
Public Benefits       $2,364,429    $3,004,315
Public Costs                  $0    $2,032,312
Net Public Benefits   $2,364,429      $730,457
Return on Investment      N/A           1.48

Some, undoubtedly, will focus on the return on investment (ROI) ratio of 1.48 if the tax rebate incentive is used. (There is no such ratio if there are no incentives, as there is no investment.) The study explains the ratio this way: “for every dollar invested, the city will receive the initial dollar plus an additional 48 cents in return.”

That sounds like a good deal, and the ratios like this that are calculated by CEDBR are often used by the city to justify incentives.

But there is another way to look at this deal: the net value to the city. In this case, if the city doesn’t offer the incentives, the benefits to the city are $2,364,429. If incentives are used, the benefits are $730,457. This means that if the city does nothing, it is $1,633,972 to the better.

That’s right: Even though the city has an opportunity to make an investment with a purportedly high ROI, it would be better off, dollar-wise, if it did not make the investment.

The analysis concludes that with the tax rebate program, there will be more construction jobs. But, caution the study authors: “Please note, the jobs supported in 2012 and 2013 are not net new jobs — they are jobs that already exist. The analysis simply identifies a funding stream for these jobs.”

In a separate but similar analysis dated March 22, 2012 prepared for Sedgwick County, some limitations of the analysis were itemized, as follows:

It was beyond the scope of this analysis to account for:

  • Changes in household consumption due to a change in homeownership.
  • The impact of renters who become owners. The program would likely encourage renters to become homebuyers. As these individuals leave the rental market, there may be adverse effects, including falling rental rates.
  • An increase in demand. Although an increase in new home purchases, above existing demand, is likely if incentives are offered, the actual increase in demand has not been quantified.
  • Any increase in demand that offsets future home purchases. It is likely that any increase in new home purchases will simply offset future home purchases as seen in the national Cash for Clunkers program.
  • A change in the price of new homes due to additional supply or higher demand.
  • A fall in home prices, or the associated tax collections, from existing homes. There is a strong likelihood that the increased demand in new homes could lower the value of existing homes.
  • Sunk costs. All costs associated with the creation of a new development, including specials, are viewed as sunk costs. Because they have already occurred, these sunk costs are not included in the analysis.
  • Increased cost of public services. Incentives provided to rural areas could increase public costs as new services are required, including roads, sewer, fire and the like. These increased costs are location specific and not included in the analysis.
  • Cost associated with not providing incentives. The costs associated with a poor new home market have not been analyzed. Without incentives, new home purchases are expected to be lower. This could have negative consequences to builders, developers and taxing entities.

Some of these problems I presented to the city council in my testimony delivered at the February 14th council meeting. Specifically, I warned council members of the devaluing of existing homes, the “cash for clunkers” effect, the costs of providing city services to homes that aren’t contributing property tax to pay for them, and the question of how much new activity will be induced: “Related to this is the question as to how much new activity this program will induce. Often government takes credit for all economic activity that takes place. This ignores the economic activity that was going to take place naturally — in this case, new homes that are going to be built even without this subsidy program … But, the city has to give up collecting property tax on all these homes — even the ones that would be built anyway.

In the case of a new home property tax rebate program for Sedgwick County, the study concludes that the benefit of the program to the county is negative $1,832,294 — a huge cost.

Missing candor

Now that the CEDBR study is released, we can see how city staff failed to present the entire economic impact of the tax rebate program to citizens. Here’s what city staff presented to council members, and by extension, all Wichitans:

“The Center for Economic Development and Business Research at Wichita State University analyzed the fiscal impact of the proposed New HOME incentive program on the City’s General Fund. The analysis compares the present value cost of incentives to the present value benefits of direct and indirect jobs created and construction expenditures. In this case, a 1.48 to one ratio of benefits-to costs is reported.”

Every word in this statement is true. But what’s missing is that if the city does nothing, it is $1,633,972 better off.

City staff had this information. Sources tell me, however, that staff did not present it to council members or the public before the council voted on the program. We are left with this conclusion: City staff presented only the information from the study that promoted the result the city wanted. This is lying by omission.

This is not the first time city staff has misled the council and the public. Regarding the economic impact of subsidies to the Ambassador Hotel, the city touted a positive cost-benefit ratio to one fund, while ignoring a negative impact to a much larger fund. The difference was a factor of 23 times. Later the city backpedaled, saying that it didn’t intend for downtown projects to be evaluated on the cost-benefit ratio to the debt service fund. See In Wichita, economic development policies are questioned.

At some time council members and citizens need to demand that someone be held accountable for this behavior. Demands for accountability are not likely to come from the city council, as many members have shown themselves willing to overlook all facts and reason in order to promote their goals. The editorial board of the Wichita Eagle does the same. It remains important for citizens to perform this watchdog function.

Wichita Eagle reporting on this matter is at Sedgwick County won’t join property tax rebate for new-home buyers.


2 thoughts on “Incentive program ignores ‘One Lesson’”

  1. Wow, very misleading with what they presented to Council. Another easy way to look at this is what the ending fund balance of the General Fund would have been with and without the incentive program.

  2. In the words of the late Paul Harvey, Bob has provided the “rest of the story,” on incentives. I won’t hold my breath expecting the city council to change their behavior based upon this politically incorrect (for all the subsidy seeking developers with lots of campaign cash) information.

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