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oftening economic conditions are bringing into focus the role of incentives in closing large project deals, according to experts who follow trends in this area. Several years of economic expansion and high demand for real estate have tempered municipalities’ need to stress incentives in their negotiations.
“Across the board, the case that a deal wouldn’t have happened but for the incentives is becoming harder and harder to make,” says John C. Biggins, president and co-founder of Stadtmauer Bailkin Biggins LLC (sbb-incentives.com), an economic development incentives advisory firm based in New York City and Princeton, N.J. “What a public-sector agency is prepared to put into a project to help make it happen is a pricing decision, and the pricing is becoming more exacting as the markets become more competitive.”
Vacancy rates will start to rise and speculative construction project plans will be shelved if past economic slowdowns are any indication. Economic developers will notice these early indicators and act to move the pricing trend the other way. “The trend changes are slow in becoming manifest, which is usually the case with things tied to the real estate industry, given how asset-heavy it is,” says Biggins. “But you’ll see within the next six to nine months that deals that get done will require incentives to get done, and some deals won’t get done. That will send a signal that it really does take more incentives to induce the marginal deal to come out of the ground. It’s the beginning of a trend.”
Incentives have a counter-cyclical aspect, Biggins relates. “It is precisely when markets and the economy are strong, vacancies are low, that’s when the costs of occupancy go up,” he says. “And the need for incentives can arguably be said to be greater. Perhaps counterintuitively, that’s also when the political will to use them diminishes.”
The inverse is equally interesting, Biggins points out. “If we go into a serious recession, then rents will fall, and the cost of occupancy goes into more attractive and reasonable ranges. But that’s precisely when governments feel they need to ‘incentivize’ most. It’s also when competition between two adjacent tax bases–cities or states–can get most intense.”
States Craft More Targeted Plans
Cities and states are, in fact, where any substantive incentives activity is taking place any more. Federal programs, such as those administered by the Dept. of Housing and Urban Development and the Dept. of Commerce’s Economic Development Administration, have largely gone the way of the dinosaurs. But Biggins leaves open the possibility of a countertrend. “If a more significant recession sets in, that will begin to create the economic conditions and political conditions for more federal support of state and local efforts,” he suggests. “But that is a matter of speculation right now, and it’s less likely to happen under a Bush Administration than under a Democratic one.”
Seeking to improve their return on investment, policymakers are crafting more targeted incentives programs. Much of that return is tied to a project’s ability to attract other projects and suppliers, hence the increasingly common industry cluster approach to designing incentives. States and municipalities recognize the tendency of employers to congregate, which attracts labor. So their resources are better spent targeting expansion activity where that will more likely be the case.
“It’s important for economic development programs to focus on the highest-yielding activities, but not to assume that unless you’re doing a cluster project you’re not going to incentivize economic development,” Biggins cautions. “There are only certain types of circumstances where the organic ingredients are there for [clusters] to develop, where you can promote it as opposed to trying to create it. A great number of good, solid projects are worth doing even if they don’t spawn one of these clusters.”
Another trend unfolding in the incentives arena is heightened use of monitoring measures to ensure their effectiveness. “The regulatory aspects of the process are becoming increasingly more sophisticated and more thorough,” says Biggins. “That is subject to the overarching qualifications that all government regulation needs to be reasonable, not overreaching and take into account the cost and feasibility of compliance. The trend is toward more rigorous tracking. Enforcement is a good thing, because it helps maintain the integrity of incentives programs. That is good for all parties.”
On occasion companies do fail to comply with incentives requirements and take benefits without delivering the public’s benefit of the deal, says Biggins, and the public sector can be remiss in ensuring its own interests are served. Those few cases threaten to undermine the entire process. “The political backdrop for these programs is an ever-present influence, so any perceived vulnerability is an invitation to a level of scrutiny beyond the merits of the program,” he notes.
A final and related trend in the incentives field worth noting, says Biggins, is its increased professionalization, both in terms of the public sector and private practitioners. Driving this trend is the consensus that incentives are best applied to projects on the basis of their merits, not for political reasons. “All of these trends point in the same direction, including use of incentives-analysis software tools,” Biggins asserts. “And that is to bring about a more ‘regularized’ and transparent process, which is one in which professionals flourish.”
A Winner in Florida
Biggins’ firm recently helped Chase Treasury Technologies Corp. win a Capital Investment Tax Credit for a facility in Tampa, Fla. It represents a new, targeted program that is focused on technology sectors the state could cultivate into clusters. “It’s not a grant; it’s not a capital investment in a project. It’s a tax credit, and the benefits become self-funding,” says Biggins. “There’s only a credit if there’s tax liability, and there’s only tax liability if there is economic activity. The state is giving only a portion of the tax revenues it would have received but for the project deciding to locate there. It fires on all cylinders in terms of the key trends in this industry.”
The credit is focused on highly desirable industries and jobs, and significant economic activity will follow the technology transfer the project represents, Biggins posits. “There is a high degree of economic efficiency for the so-called tax expenditure in which the project benefits only to the extent the state benefits in both direct and indirect terms,” he says. The Chase project represents a creative use of the program in as much as it was applied to a financial services company as opposed to software development, microchips or some other high-tech industry.
All 50 states are laboratories for development of such programs, and they base new incentives on what works elsewhere. “Florida has learned from the experience of other states that have one or another variation on this theme,” says Biggins, “and they’ve combined the best elements they’ve seen into this program.”
SIDEBAR:
Hawaii Considers High-Tech Tax Overhaul
Boosters of Hawaii’s fledgling high-tech industry are hoping a bill currently before the state legislature will become law and jump-start efforts to attract more than just tourists to the island state. At press time, state lawmakers were preparing to vote on a 10-provision measure that would dramatically improve Hawaii’s standing as a state in which to locate high-tech enterprises.
The centerpiece provision of House Bill 175 is a 100 percent credit on cash investments in qualified high-tech businesses (QHTB) on a front-loaded basis over five years. The measure calls for a 35 percent credit in the year of investment, 25 percent in the first year following investment, 20 percent the following year and then 10 percent each in the third and fourth year following. It is designed to give full, 100 percent return for investment up to US$5 million. If the QHTB fails to operate as such starting in the second year following, then the credit for the previous year is recaptured.
“This provision would set Hawaii apart from other jurisdictions,” says Ray K. Kamikawa, an attorney with Honolulu law firm Chun, Kerr, Dodd, Beaman & Wong, and the former tax director for the State of Hawaii. “It is meant to foster a change of mindset,” he says, and to address a shortage of local angel investment.
“Another important provision in the measure is to expand he definition of what is considered a qualified high-tech business,” says Kamikawa. “That would make it more inclusive of the kinds of industries we want to attract to Hawaii, which include astronomy, sensor and optic technologies, non-fossil fuel energy and ocean sciences. We also want to encourage more production of biotechnology-related products.”
The bill also creates incentives for contractors and developers to construct or remodel their commercial buildings to be more high-tech friendly; it provides a 4 percent refundable income tax credit for this purpose.
