GMU Economist Podcast

Interview With GMU Economist Matt Mitchell

Scholar Says Incentives Don’t Work and Can Punish the Community

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TRANSCRIPT

ILONA: Welcome to All things Hudson Valley. In this podcast we talk about the proposed Kingstonian development and the rosy economic projections the developers say are sure to follow. We also look at how much money the Kingston school district stands to lose. I had the good fortune to speak with Matt Mitchell, an economist at George Mason University, who studies economic development incentives. My questions were about the wisdom of economic incentives at a time when local governments are slashing their budgets because of the COVID induced economic crisis. Matt doesn’t live in New York State, so I told him that Liz Krueger who chairs the New York State Senate Finance Committee, was on the radio earlier in August. She explained that one of the reasons the New York state budget was in trouble was because of Albany’s largesse with economic development. We spoke about the Kingstonian and its $30 million PILOT, which is an acronym for payment-in-lieu-of-taxes. That’s a fancy word for a tax break. If this is okayed, local government and school districts would be deprived of about $30 million over the next 25 years. This tax break still needs to be approved by the Kingston school board, the Ulster County legislature and the Ulster County Industrial Development Agency known as the IDA.

MATT: Aha, okay.

ILONA: So we have an IDA project in Kingston, and it’s a multi use development that consists of a boutique hotel, a 143-unit luxury apartment complex, 9,000 square feet of retail space and an air conditioned and heated garage.

MATT: Ah, okay.

ILONA: And the construction value is $57.8 million, the assessed value using an income valuation method is $19 million and the property tax on that would be 932,000 and instead they’re offering to pay $40,000.

ILONA: They’re also asking to be exempted from paying $325,575 in mortgage recording tax and $1.48 million in state and local sales and use taxes.

MATT: Okay, cool. Well, so let me tick down some of what you said. Really early on, you mentioned one thing you said they were exempted from mortgage recording tax and also exempted from sales involved in the construction. That was probably the only thing you named that most economists would say was a legitimate tax write off. And what I mean by that is it’s generally agreed that if two people earn $100, let’s say you and I each earn $100 but you are able to do that with zero expenses and I’m able to do it, it takes me I spend $20 buying materials in order to earn $100. Generally, most economists say that I should only be taxed on that $80. In other words, I should be able to write off business expenses. So costs of doing business, it’s generally agreed that firms should write those off now.

03:24

ILONA: Wait, there’s just one one thing I forgot to mention.

MATT: Okay, sure.

ILONA: The developer happens to own a hardware store.

MATT: So he should be able to get a lot of that stuff for free or for discount. Yeah. That’s interesting. So anyway, I just wanted to point that out. Basically we should exempt business to business transactions. That’s, that’s not a particularly controversial thing. It’s a little weird and controversial if the state policy is not to exempt it, but they only exempt it for one firm that’s problematic like everybody else is bearing a burden and this firm isn’t. But anyway, I just wanted to point that out.

ILONA: I also asked how we could measure the cost of community services.

MATT: So, when you talk about measuring the cost of community services, I assume what you’re saying is okay, there’s new activity here. This requires new streets new, you know, extra police presence, all that stuff. How do you measure that? Is that kind of what you’re getting at?

ILONA: Yes.

MATT: Yeah. It’s a great point. At the moment, I don’t know if anybody has looked at that. It might be hard to do it across so many different kinds of activities. But I would point out that that’s exactly the way you should be thinking about it. So you know, in my residential area, there’s people who live in PID districts, public improvement districts, and the basic idea is Oh, we just put a new bike lane, and some new grass and stuff that you benefit from, so you actually have a surtax added to your property tax. They should have to pay higher, they should have have to pay higher taxes based on that, not get a tax exempt exemption. So at the very least, the general consensus here is that any marginal increases in a local community’s cost of community service should actually result in in the developers paying a little extra, certainly not getting a tax break. You should pay for the marginal cost you impose on the public.

ILONA: The developers say they’re providing tens of millions of dollars in benefits to the community, that they’re going to spark tens of millions of dollars in economic activity, and that they can’t build the project without the subsidy.

MATT: So you know, in terms of their numbers, I would have to dig into it, but I would guess they’re not particularly valid. And the reason is that all of this they use some very similar talking points to other types of development and subsidies. And they almost always fall into this double-edged sword. And what I mean by that is, they either make .. they want to make the claim that oh, this stuff wouldn’t exist but for the subsidies, they always want to make that claim that the economic activity here would not happen if it weren’t for the subsidies. And they want to do that because they want to, you know, make a claim that they are the ones that brought in the business. So the problem is, subsidies don’t make sense if that’s true and subsidies don’t make sense if that’s false.

07:46

ILONA: This touches upon so-called inefficiencies. Another economist at George Mason wrote a study with this scenario : You could set up an orange grove in Wisconsin and you could grow oranges and you could create jobs, and you could stimulate economic development. But is Wisconsin the right place? And is it worth the extra cost? And is it worth a subsidy?

MATT: So if it’s true that the economic activity would not exist but for the subsidies, then you’re in the scenario of the orange groves in Wisconsin, where if they wouldn’t locate there but for the subsidies, then it’s probably not a good location for that development.

08:28

ILONA: There’s no bedrock under the soil where the developers are planning to build. The developer himself says that even 40 feet down the soil is like toothpaste. And their own geotechnical engineer said not enough exploration had been done to see whether the soil could support the structure. In fact, a garage once stood on the land where they plan to build. But that garage had to be torn down. And in a presentation a few years ago, developer Joseph Bonura acknowledged that soil quality might have been a factor.

MATT: And you know the details about the soil on previous garage being torn down is evidence that suggests that this isn’t a great location for this type of economic activity. So, you know, economists will sometimes call that X-inefficiency like basically taking on costs that are unnecessary and they’re doing it because they’re getting a government favor or government privilege that they wouldn’t get in the market.

ILONA: What kind of subsidy? X?

MATT: X inefficiency is what is what economists call it. So it’s the letter X. It’s maybe not the most descriptive, but the basic idea here is it’s it’s inefficiencies that arise as a result of anti-competitive protections. So this firm, you know, is getting some privileges that other other competitors in the market wouldn’t normally get and so as a result of that, they don’t need to be as attentive to costs. And they don’t need to pay as close attention to the types of investments that they’re making and so they’re more likely to make bad investments. So that’s a double-edged sword. So the idea here is that, hey, we’re going to try to make the case case to you, the taxpayers, that this economic activity wouldn’t happen here but for the subsidies. The problem is, well, if you’re right in that, then it probably shouldn’t happen. And if you’re wrong in that, then you’re just wasting taxpayer funds because they would have made the investment whether you gave them the money or not, and you’re just handing away taxpayer resources. And there’s an opportunity cost to those resources, you know, to put that in, you know, the perspective of, you know, where did these funds come from, if it’s a property tax abatement, nationwide, there are about $13.5 billion in local property tax abatements every year. So states basically give away about $13.5 billion to local economic developers. Well, there’s a little over 50 million public school students, so that means that it’s about $266 per year per student that is siphoned off of the property tax base. Because property taxes are one of the major sources of funding for local schools.

ILONA: I did a little math on that, by the way. We have 6,400 students in the Kingston School District. And if every year out of that 932,000, I think it’s about 580,000 that would go to the school district, and so divided by 6,400, it turns out to be a little bit under $100 a year.

MATT: And that’s actually interesting, because, you know, my numbers here are for total abatements and you’re saying this one abatement is about $100. So that’s huge. That means that this is a this is a pretty big subsidy in terms of, you know, the total the total amount of subsidies. Yeah, you know, there is there is a cost. But the problem with this is it’s not easy to follow the money and think about, think about the cost. You know, you don’t think about, oh, this property normally would be taxed at a certain amount. And I mean, the numbers you gave are pretty astounding. It would normally be $932,000 tax, and instead it’s a 40,000. Well, you know, the other firms still end up having to pay their property taxes. So there’s there’s basically two ways the public loses in terms of finances. One is, all else being equal, other property has to be taxed higher, or two, public priorities get less revenue as a result of this.

ILONA: In fact, the exact number lost to the Kingston school district because of this PILOT is closer to $97. But that doesn’t count the rest of the tax exemptions from PILOTs. The calculations aren’t final because data from the school board, the Ulster County IDA and the tax rolls don’t match. And not all districts file a form that they’re supposed to called GASB 77 that spells out just how much revenue is lost to tax breaks. But in the Town of Ulster alone $90 million worth of equalized properties receive tax breaks. Equalization is a formula that spreads school taxes evenly over different taxing jurisdictions. And in Kingston, that number is about $45 million of equalized property. Some property owners do make PILOT payments, but nowhere near what they would pay if they weren’t partially subsidized. Preliminary calculations show the Kingston school district forgoes $3,746,403 in lost school taxes because of IDA giveaways, at least for the 2019 2020 school year. That translates to $585 for each student. You can find the Excel spreadsheets with these calculations at the Hudson Valley Vindicator. That’s more than double the number that Matt quoted.

14:02

We also talked more about how the burden is shifted onto remaining taxpayers. Thomas DiNapoli is the is the Comptroller of the State of New York. And he has said many times that when there are these abatements or PILOTs, or any kind of exempt property, the rest of the people pay more. The rest of the taxpayers pay. And I searched high and low to find out exactly what he meant. And the best analogy I got was that it’s like if your entire office orders pizza, and you all split the cost, and all of a sudden you got a new person coming in, but they don’t pay their share, and this goes on for 25 years.

14:41

MATT: Yeah, I think that’s a very good analogy, that’s the way to think about it. And the reason they’re saying it’s no cost to the taxpayers is because they are making the assertion that — I think — that this economic activity wouldn’t take place but for the subsidy. Yeah. You know, but you know, we induce them to come here. So now we can we can cut them a deal on the property tax. You know, there’s a there’s just a host of problems with that kind of argument, everything from, you know, the fact that this has an opportunity cost in terms of higher tax rates on everybody else, to lower public revenue streams for everybody else, especially the public schools, to that the fact, what I find most compelling is just that this stuff doesn’t work. So you can look across, we now have like 30-40 years’ worth of research, hundreds of studies of tax abatement programs. And there is very little evidence that they provide any kind of benefit to the broader communities that pay for them. There are if you’re, if you’re trying to figure out if these things work scientifically, you know, what you would want to do, there are basically two options. One, you could see if subsidized firms outperform the rest of the economy. And you can do that and the studies that look at that basically find they probably do. There’s a surprising number of studies that find that they might not. But they probably do. But I don’t think that’s a very helpful way to look at it because nobody ever gave a subsidy to Firm X and said, You know, that’s because we all want Firm X to outperform the rest of you. Instead, you know, really going back to Alexander Hamilton, any time a policymaker says, we’re going to give a subsidy to Firm X, it’s because they say it’s going to benefit all the rest of us, too. We’re all going to benefit from this. You know, nobody ever tried to give away public money to a private interest and claimed that it was only to serve the private interest. They’re at least going to tell some story about how it’s going to benefit the rest of us. But when you look at the studies that evaluate it in terms of how do the rest of us fare, and so these are studies that look at, you know, per capita GDP, or the unemployment rate in the entire community or income in the entire community, there’s virtually no evidence that subsidies are a way to increase those types of broad measures of well-being.

ILONA: Oh my gosh.

17:18

MATT: And in fact, we’ve got plenty of reasons to think that it actually over the long run undermines well-being. And there’s, there’s other things that matter. You know, there’s good evidence that generally low taxes and, you know, few business regulations are generally pretty good for economic development. Spending on public goods, genuine public goods, can generally be pretty good for an economy. So you know, there’s a little bit of evidence for the for the left and the right there, by the way. But spending on particular businesses, there’s not much evidence that that benefits the broader economies that pay for them.

17:55

ILONA: But the developers say that between the garage, the kiosks, the bathrooms and the affordable apartments, they’re responsible for about $40 million in benefits.

MATT: Right, right. So on the, you know whether the estimates are realistic, without digging into the specifics of what they’re saying, I can tell you two mistakes that are extremely common in these types of analyses that industries put forward. And I would bet, you know, dollars to donuts that they’ve probably made these mistakes. So, one is the what what’s kind of sometimes called the “but for” assumption, and this is the basic idea that the investment would not happen but for the subsidies. The problem is that the best information we have suggests that in most instances, the investments actually would take place without the subsidy. So the best estimate is that a typical subsidy sways somewhere between two and 25% of subsidized firms. So another way to put that is between 75 and 98% of the time, the firm actually would have just made that investment anyway, and they’re happy to, you know, avail themselves of the subsidies after they’ve made the decision to make the investment. So why would, you might be interested in wondering why why would that be? I mean, this a fair amount of money. And the reason is that even though it can be a fair amount of money, it’s typically dwarfed by other factors.

ILONA: Could such a factor be that one of the developers already owns the land? That’s Brad Jordan, who owns Herzog’s and the mall.

MATT: Yeah, that suggests he was already planning. He has reason to invest there anyway. Yes, exactly. Exactly. Now, that becomes important in the calculus here. Let’s say that I sell you a drug that I claim, you know, it’s an elixir that I claim is going to cure you of, you know, some sort of rash. Well, if there is in actuality, between a two and 25% chance that the elixir is actually going to cure you of the rash, then the value of the drug to you, and, you know, you’d be you’d be willing to pay 100 bucks to get cured of this rash. The true economic value is not $100. But it’s somewhere between two and $25. Because you have to discount the potential value that you foresee from this drug by the probability that it actually does what I’m telling you that it’ll do. Does that make sense?

ILONA: Yeah, sure. Absolutely.

MATT: Yeah.

ILONA: The developers say the project will spark a lot of economic growth. They released figures provided by an economic development consultant pointing to millions of new dollars circulating in the local economy, and they stress that but for the PILOT, this growth won’t happen.

MATT: We will never know with certainty exactly what they would do absent subsidy. We can’t get inside their heads. But that’s where you say, Okay, if that’s the case that it wouldn’t be built but for the subsidy, you’re essentially saying it’s in the two to 25% of cases. But then you really need to make the case to us that it should be built, because the presumption is it shouldn’t be, if it’s not suitable for investment. If you wouldn’t do it based on your private cost benefit analysis, then why should you do it based on analysis that allows you to have private gains, but the costs are sloughed off onto taxpayers. There’s a second reason why those estimates are typically off, and that’s on the cost side. So I’ve just told you the benefits side, this one, sometimes they will include this, but it’s still extremely rare. I would bet that they don’t account for the fact that these 30 million, when that’s taken out of the economy, you know, that’s it that’s not manna from heaven. That has to be taxed out of the economy, and that if left in the hands of businesses and consumers would have involved its own spillover benefits. So when they talk about, you know, these extra jobs created, there’s nothing wrong with that kind of argument. Sure. You give a dollar to a construction worker, and he’s gonna spend, you know, 20 cents of that at the McDonald’s and on some, some on his housing and all sorts of other things. But that’s also true for the taxpayers, who don’t have the money as a result of it being taken out of their pockets.