The City of Wichita has passed a revision to its economic development policies. Instead of promoting economic freedom and a free-market approach, the new policy gives greater power to city bureaucrats and politicians, and is unlikely to produce the economic development that Wichita needs. Sedgwick County will also consider adopting this policy.
The city wants to have policies that everyone can understand, but it also wants flexibility to waive policies and guidelines in light of mitigating factors.
Here’s an illustration of how difficult it is to adhere to policies. The draft proposal of the new economic development policy states: “The ratio of public benefits to public costs, each on a present value basis, should not be less than 1.3 to one for both the general and debt service funds for the City of Wichita; for Sedgwick County should not be less than 1.3 overall.”
The policy also states that if the 1.3 to one threshold is not met, the incentive could nonetheless be granted if two of three mitigating factors are found to apply. But there is a limit, according to the policy: “Regardless of mitigating factors, the ratio cannot be less than 1.0:1.”
Last August the city council passed a multi-layer incentive package for Douglas Place, which is better known as the Ambassador Hotel and environs. Here’s what the material accompanying the letter of intent that the council passed on August 9, 2011 held: “As part of the evaluation team process, the WSU Center for Economic Development and Business Research studied the fiscal impact of the Douglas Place project on the City’s General Fund, taking into account the requested incentives and the direct, indirect and induced generation of new tax revenue. The study shows a ratio of benefits to costs for the City’s General Fund of 2.62 to one.”
So far, so good. 2.62 is greater than 1.3. But the policy applies to both the general fund and the debt service fund. So what about the impact to the debt service fund? Here’s the complete story from the WSU CEDBR report:
Cost-benefit ratio City Fiscal Impacts General Fund 2.63 City Fiscal Impacts Debt Service 0.83 City Fiscal Impacts 0.90
The impact on the debt service fund is negative, and the impact in total is negative. (A cost-benefit ratio of less than one is “negative.”)
Furthermore, the cost of the Ambassador Hotel subsidy program to the general fund is $290,895, while the cost to the debt service fund is $7,077,831 — a cost factor 23 times as large.
So does the city have the wherewithal to stick to the policies it formulates? In my experience, not always. In this case, the city didn’t make this negative information available to the public. It was made public only after I requested the report from WSU CEDBR. It is not known whether council members were aware of this information when they voted.
There are, however, other factors that may allow the city to grant an incentive: “In addition to the above provisions, the City Council and/or County Commission may consider the following information when deciding whether to approve an incentive.” A list of 12 factors follows, some so open-ended that the city can find a way to approve almost any incentive it wants.
At yesterday’s city council meeting, when explaining the policy to the council, Wichita economic development chief Allen Bell said there should be “rational criteria” for when exceptions can be considered. We should also ask for truthfulness and complete disclosure, including negative factors.
When considering cost-benefit ratios, we also need to realize that the “benefits” in the calculation are in the form of increased tax revenue paid to the city, county, etc. There is no consideration of actually rewarding the taxpayers that pay for — and assume the risk of — economic development incentives. Furthermore, these benefits are not like profits that business firms earn. Instead, they are in the form of taxes that government takes.
Speculative industrial buildings
A new feature of the policy implements property tax forgiveness for speculative industrial buildings. The proposed plan had a formula that grants a higher percentage of tax forgiveness as building size increases, but the council eliminated that and voted a 100 percent tax abatement for all buildings larger than 50,000 square feet.
Given tax costs and industrial building rents, this policy gives these incentivized buildings a cost advantage of about 20 percent over competitors. That’s very high, and makes it difficult for existing buildings to compete. Probably no one will build these buildings unless they qualify for and receive this incentive.
While the city hopes that these incentivized buildings will generate new jobs in Wichita, there appears to be nothing in the policy that prevents existing companies in Wichita from moving to these buildings. This simply moves jobs from one location to another, and would harm existing landlords.
While the policy was designed to encourage large buildings instead of small, there appears to be no limitation on the size of space someone can rent. A building 100,000 square feet in size gets 100 percent tax abatement. But the space could be rented out in smaller parcels to multiple tenants, making it easy to steal local tenants from another landlord.
Finally, are pre-built facilities really necessary? Wind energy firms in Newton and Hutchinson built their plants from ground up.
Since many of the economic development incentives involve relief from paying taxes, we have to ask whether our tax levels and tax policies are discouraging business investment. Now we have an answer.
This year the Tax Foundation released a report that examines the tax costs on business in the states and in selected cities in each state. The news for Kansas is worse than merely bad, as our state couldn’t have performed much worse: Kansas ranks 47th among the states for tax costs for mature business firms, and 48th for new firms. Wichita was cited in the report, and the city did not do well. See Kansas and Wichita lag the nation in tax costs.
Wichita’s record on economic development
Earlier this year Greater Wichita Economic Development Coalition issued its annual report on its economic development activities for the year. The shows us that power of government to influence economic development is weak. In its recent press release, the organization claimed to have created 1,509 jobs in Sedgwick County during 2011. According to the Bureau of Labor Statistics, the labor force in Sedgwick County in 2011 was 253,940 persons. So the jobs created by GWEDC’s actions amounted to 0.59 percent of the labor force. This is a very small fraction, and other economic events are likely to overwhelm these efforts.
In his 2012 State of the City address, Wichita Mayor Carl Brewer took credit for creating a similar percentage of jobs in Wichita.
Rarely mentioned are the costs of creating these jobs — the costs of the incentives and the cost of the economic development bureaucracy. These costs have a negative economic impact on those who pay them, meaning that economic activity and jobs are lost somewhere else in order to pay for the incentives.
Also, at least some of these jobs would have been created without the efforts of GWEDC. All GWEDC should take credit for is the marginal activity that it purportedly created. Government usually claims credit for all that is good, however.
The targeted economic development efforts of governments like Wichita and Sedgwick County fail for several reasons. First is the knowledge problem, in that government simply does not know which companies are worthy of public investment. In the case of the Wichita and Sedgwick County policy, do we really know which industries should be targeted? Are we sure about the list of eligible business activities that subsidies can be used to pay? Is 1.3 to one really the benchmark we should seek, or we be better off and have more jobs if we insisted on 1.4 to one or relaxed the requirement to 1.2 to one?
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 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.
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 that Wichita and other cities engage in: “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.’”
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 is an example of such a policy. Abating taxes for specific companies through programs like IRBs and other economic development programs is an example of precisely the wrong policy.
We need to move away from economic development based on this active investor approach. 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. Wichita and Sedgwick County are moving in the wrong direction.