July 2005
  Incentives Deal of the Month
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Are Some Companies
More Equal Than Others?

North Carolina lawsuit aims to derail Dell et al


by ADAM BRUNS, Site Selection Managing Editor


       Eminent domain may have taken over the headlines, but good olí incentives are still hot as a firecracker.
       The US$279 million that Dell is slated to receive from state and local concerns for building a
Will They Have to Put the Dirt Back? A suit just filed on behalf of seven plaintiffs by the North Carolina Institute for Constitutional Law calls for the incentive package granted to Dell Inc. for the new assembly plant under construction on this site to be rescinded, and the laws enabling it to be declared unconstitutional at the federal and state levels.
new assembly plant in Winston-Salem has been challenged in Wake County Superior Court by former North Carolina Supreme Court Justice Robert Orr, now executive director and senior counsel for the North Carolina Institute for Constitutional Law.
       Orr and the seven property-owning plaintiffs from five counties around the state are not just challenging that package. They want the whole kit Ďní caboodle stricken from the proverbial economic development toolbox on the grounds that paying corporations to come is unconstitutional. The defendants range from James T. Fain, III, secretary of the N.C. Department of Commerce, to local economic developers and Dell itself.
       At issue is the passage of special legislation on Nov. 4, 2004, to award Dell $242 million in state incentives. The language in the complaint will seem familiar to those in the industry, as it echoes the findings of the U.S. Sixth Circuit panel last year in its ruling against incentives for the DaimlerChrysler expansions in Toledo, Ohio:
       "The Dell legislation discriminates in favor of in-state economic activity and against interstate commerce thereby violating the Commerce Clause of the United States Constitution and otherwise violates the U.S. Constitution and various provisions of the North Carolina Constitution," states the lawsuit. In other words, inducing companies to locate in North Carolina via the specific tax breaks and other incentives outlined in the suit is no more legal than it was in Ohio. Oddly enough, the amounts are nearly equivalent.
The Cuno v. DaimlerChrysler ruling, which dealt with an incentive package for an expansion of this plant in Toledo, Ohio, has prompted challenges to incentive programs in half a dozen states.

       "The tax credits provided to Dell are very similar to those at issue in Cuno, and we believe are unconstitutional under the Sixth Circuitís holding in Cuno," states the NCICLís Web site.
       Similarly, claim the plaintiffs, the $37 million to be doled out by Winston-Salem and Forsyth County violate the state constitution.
       One policy at issue is the William S. Lee Quality Jobs and Business Expansion Act (Bill Lee Act), which allows for both the granting of subsidies and the designation of economic distress rankings to counties for the provision of additional aid.
       At issue here is the notion that Forsyth County, which for 10 years has been among the lowest-distress counties in the state according to the stateís own rankings, has for the purposes of the Dell credit program been given the equivalent of a high-distress ranking. The lawsuit calls the legislative language allowing such shifting "arbitrary and irrational."
       The complaint goes on to note that both the new law and the Bill Lee Act also violate the Equal Protection Clause of the U.S. Constitution, by not allowing the plaintiffs similar access to such benefits. Other clauses violated? The N.C. Constitutionís Separation of Powers Clause (by allowing the Sec. of Commerce and executive branch such power over taxing authority), Exclusive Emoluments Provision ("Dell is provided a special tax benefit merely for operating its own private business"), Public Purpose Clause and Uniformity of Taxation Clause. Finally, in Count 15, the suit calls the new manufacturing credit "impermissibly vague and ambiguous" because of the latitude it affords the Sec. of Commerce in determining tax credit eligibility.

Letís Get Specific
        In an interview with Site Selection this week, Orr says that the recent U.S. Supreme Court ruling on eminent domainís legality in serving a "public purpose" actually gives his side more momentum, not less — not so much from a legal perspective (itís a state constitutionís public purpose in the Dell case) as from that of public policy.
       "The immediate negative reaction to the Kelo decision — I think the House has already passed legislation limiting use of eminent domain — plays into the public policy argument weíre trying to make."
       Only with incentives, says Orr, the sense of violation is even greater.
       "With eminent domain, you take somebodyís property and give it to a private developer. At least in taking physical property, youíre entitled to just compensation for that taking. In the incentives game, the government uses the power of taxation to take the money youíve earned and turn around and give it to a private corporation. Arguably, the taxpayer gets little if any in return. In Dellís case, the money ultimately helps benefit Dellís bottom line. I think when the public and politicians start recognizing that what is happening in the incentives game is even more egregious than what happened in Kelo, weíll see a greater interest in trying to make changes in the incentives practice."
       The special North Carolina legislation, created two days after Election Day 2004, invented a new tax credit for large computer manufacturers against corporate income and corporate franchise taxes, based on unit output and employment level. The legal complaint notes that a given taxpaying company may claim up to 100 percent of its tax liabilities in these areas, and notes that "most tax incentives under current law allow the taxpayer to offset no more than 50 percent of its tax liability."
       The complaint also notes that the 1,200-job threshold such a taxpayer must meet now includes, for the first time, jobs created by one or more "related entities and strategic partners." Then it makes the claim that, based on the state law requirement that a company must be planning to invest at least $100 million in private funds, "upon information and belief, Dell plans to use foreign profits to make this $100,000,000 investment, thus securing a more favorable federal corporate tax rate."
       In other words, Dell is merely taking advantage of the 2004 American Jobs Creation Act by bringing back overseas money.
       In addition, claim the plaintiffs, "pursuant to the legislation, unlike situations involving other similar tax credits offered by the State, Dell does not have to meet a wage standard to qualify for the credit." And they state that, unlike other tax credits like the Bill Lee Act, this credit program does not allow credits to expire if jobs are reduced in any given year. "Thus, once Dell has attained an increased employment level of at least 1,500 it may reduce its employment level by up to 40 percent per year without being subject to a reduction in the maximum amount of the tax credit for which it is eligible," states the complaint, which goes on to list a host of other exceptions that the new law grants a computer manufacturer in order to bypass Bill Lee.
       The organization explains that itís not against economic development per se, based on the following rationale:
       "From a public policy standpoint, tax giveaway programs are controversial on economic development grounds," states the NCICL Web site. "Many economists believe that they are a waste of scarce public resources because the jobs generally would have been created anyway. Studies show that businesses looking to relocate are more concerned with quality schools, universities, parks and highways than selected tax breaks."
       Some would argue that highway and education infrastructure often are significant parts of incentive packages too.
       Extension of the Lee Act, due to expire at the end of 2005, is currently under debate in the state capital of Raleigh. The doubt incurred by that process as well as the Orr lawsuit has already put some announcements on hold, notably The Cheesecake Factory, which has been planning to open a 500-worker bakery in Nash County, contingent on certain provisions of the Lee Act and its economic development zone program.
       Finally, old rivalries die hard. In an interesting sidelight to the legal action, Orrís opponent in court, representing Dell, will be a fellow former state supreme court justice, Burley Mitchell, whose view was opposed to Orrís on the topic back when their court ruled on the legality of incentives in a 1996 case that determined economic development served a public purpose.
       Visitors to the NCICL Web site may glimpse the lawsuit in full detail, as well as a copy of a draft agreement between Dell and various local and state economic development entities.

Take It to the Feds
       Of course, other states donít have to follow suit, which would put the Tarheel State at a distinct disadvantage, should the plaintiffs prevail. The case is expected to take about a year to reach a decision — which may be long enough for some federal legislation to have a bearing.
       Itís called the Economic Development Act of 2005, introduced on May 18, 2005, by Sen. George Voinovich (R) of Ohio. Among his 12 co-sponsors are such Congressional luminaries as Senate Majority Leader Bill Frist (R-Tenn.), Sen. Mitch McConnell (R-Ky.) and Sen. Johnny Isakson (R-Ga.). The bill has now been referred to the Senate Finance Committee.
       In introducing the measure, Sen. Voinovich noted that he had enacted the now-nullified machinery and equipment tax incentive when he was governor of Ohio. (Almost simultaneously, current Gov. was doing away with the provision entirely in signing a comprehensive tax reform package.) Voinovich noted the pall that the Cuno decision had cast over deals in all 50 states, as they endeavor to compete on a truly global stage.
       "As a former Governor who had to compete against Japan, Canada, China and Europe for new business projects, I know just how important a role tax incentives can play in attracting new businesses," he said. "I can assure you that our competitors are certainly not going to stop using tax incentives. Neither should we." He went on to note the high rankings in new plants and expansions for Ohio in Site Selection between 1993 and 1997, earned in part by the stateís expanded incentives programs.
       (In fact, a look back at Site Selectionís coverage shows that Ohio did indeed lead the way, but nipping on its heels was ... North Carolina, which won the Governorís Cup title outright in 1996. That was the same year that saw Justice Orr issue a dissent in the Maready v. City of Winston-Salem et al. case that found incentives constitutional. The Maready case quickly became a case study at the John F. Kennedy School of Government at Harvard University. For extensive discussion and background, visit "North Carolina and the Battle for Business".
       The Voinovich measureís simple goal: to authorize states to provide tax incentives for economic development purposes. In his critique of the Sixth Circuit decision, Voinovich noted "a little legal fiction present in the Cuno decision. The court states that Ohio could have provided a direct subsidy to companies that undertook investment in the State. Because Ohio decided to structure the program as a tax credit, however, the court said that it ran afoul of the Commerce Clause. I do not see how a direct subsidy does not violate the dormant Commerce Clause, but a tax credit does. They are economically the same."
Sen. George Voinovich

       While a Cuno override would help manufacturers in sore need of it, said Voinovich, the ultimate reason the decision needs revisiting is that it "sets a bad precedent that, if not checked, could upset our carefully balanced federal system. One of the most ingenious aspects of the U.S. Constitution is that it leaves a great deal of power with the States... My legislation will guarantee that the States remain our engines of innovation."
       In conclusion, Voinovich noted that the U.S. Supreme Court itself had described its dormant Commerce Clause jurisprudence as a "quagmire." And he quoted a statement from Supreme Court Justice Felix Frankfurter:
       "At best, this Court can only act negatively; it can determine whether a specific state tax is imposed in violation of the Commerce Clause. Such decisions must necessarily depend on the application of rough and ready legal concepts. We cannot make a detailed inquiry into the incidence of diverse economic burdens in order to determine the extent to which such burdens conflict with the necessities of national economic life. Neither can we devise appropriate standards for dividing up national revenue on the basis of more or less abstract principles of constitutional law, which cannot be responsive to the subtleties of the interrelated economies of Nation and State.
       "The problem calls for solution by devising a congressional policy. Congress alone can provide for a full and thorough canvassing of the multitudinous and intricate factors which compose the problem of the taxing freedom of the States and the needed limits on such state taxing power. Congressional committees can make studies and give the claims of the individual States adequate hearing before the ultimate legislative formulation of policy is made by the representatives of all the States. . . . Congress alone can formulate policies founded upon economic realities."

Is Gaming the System the Real System?
       To many, the incentives game is an economic reality. But Orr and his allies think reality bites, and equate the incentives game to an addiction. He calls the Voinovich effort "misguided," especially in its attempts to link the need for incentives to keeping jobs in the U.S.
       "This has nothing to do with losing jobs overseas — what weíre concerned about is the practice of [states] outbidding each other to move companies," Orr says.
       Asked about the reality of some corporate location short lists involving U.S. cities pitted against foreign cities, Orr says the "occasional circumstance" may involve moving to Mexico versus staying in the U.S., but that the business decisions are made with regard to other factors than incentives. He quotes from a recent U.S. Supreme Court decision, Granholm vs. Heald, that referred to the challenges the Constitutionís framers faced with the prospect of "economic balkanization" in the new union of colonies.
       "What we have now is economic balkanization," says Orr. "North Carolina is looking out for North Carolina, Virginia is looking out for Virginia, Ohio for Ohio. Companies recognize this and are able to exploit it."
       So, should there be a federal policy on incentives? Barring a better idea, yes, says Orr.
       "If youíre going to have a trade policy that addresses concerns with jobs being lost overseas, then the Congress needs to be doing that, not the individual states," he says. "If the issue is ĎWhat do we do to keep the textile and furniture industries, the solution needs to be at a national level. Thatís why we have international trade treaties and the WTO. And let it apply equally among the 50 states."
       In other words, as is being played out right now on the WTO stage with the U.S. vs. Europe over Airbus and Boeing, let the countries battle it out. Meanwhile, Orr thinks anybody involved with incentives will say itís out of hand and they need to be "outlawed, stricken, prohibited on a national basis." He hopes his state will return to an across-the-board economic development package that isnít so slanted toward "the wealthiest corporations," but benefits "everybody thatís in the business of job creation and economic development."
       Orr says he recently had the opportunity to discuss the topic at the annual conference of North Carolina economic developers.
       "When I talked about the system being gamed, there were a lot of heads nodding in agreement," he says. "They understand something is wrong with the system, they just donít know how to get out of the system."
       In the meantime, economic reality continues to take form on real ground in Winston-Salem. Dell anticipates launching operations in September 2005.


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