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Local economic development: A recipe for stone soup

April 1, 2000


Ron Wirtz Editor, fedgazette
Local economic development: A recipe for stone soup

"No Catch! 72 acres of industrial tax-free land is available for improvement."

That's the pitch in Ontonagon County in the Upper Peninsula (U.P.) of Michigan, where two parcels of land have been designated as virtually tax-free shelters for the next decade for any business willing to create 25 jobs there through a state program called Renaissance Zones.

Established in law three years ago to address economically distressed areas of the state, renaissance zones waive almost all state and local taxes on a Michigan business, including the single business tax, state and local income taxes, state education tax, local property taxes and utility user tax. The state originally designated four other sites in the U.P. in nearby Gogebic and Houghton counties and created an additional zone at the former Sawyer Air Force Base in Marquette County this past December. Combined, the seven sites encompass more than 3,300 industrial acres.

Other states are following that lead. Last year, the North Dakota Legislature approved its own Renaissance Zone initiative, modeling it after Michigan, according to a state official there. Earlier this year, Fargo became the first designated zone, while several other cities are preparing applications. Minnesota's new Enterprise Zone Program offers more modest tax credits to businesses that create or retain jobs in the cities of Breckenridge, Dilworth, East Grand Forks, Moorhead, Ortonville and Duluth.

While each program has its unique features, each demonstrates the considerable influence of the state on local business subsidies. Federal resources also provide a helping hand.

In fact, local economic development tends to be a bit like stone soup—it doesn't need much to get off the ground. Just a few state loans here, a little block grant money there, maybe a pinch of federal assistance—and before you know it, two new companies have come to town. And it was so easy.

That's not to say there are no local resources involved, or to diminish the local role of marketing, negotiating and closing business assistance deals-no easy task considering the tangle of state and federal programs and related regulations. But without this hopper of nonlocal resources, many local business subsidy deals would never happen.

He ain't heavy, he's my (Big) Brother

In many cases, state and federal resources are used for public infrastructure projects—the roads and sewers necessary for a business to even consider locating in a particular city. Such assistance can hardly be labeled a business subsidy, but it does tend to lay the groundwork for local deals with businesses.

Through a number of vehicles, however, states also provide the actual subsidy to help close a deal for a local community. Last year, the Wisconsin Department of Commerce provided $42 million in grants and loans to more than 400 businesses, according to a department official. It also recently announced a new $9 million program with three financing programs "to help diversify the business base in local communities."

Minnesota budgeted $27 million this year for three of its largest assistance programs—the Minnesota Investment Fund, Job Skills Partnership and Small Business Development Loan Program—according to an official with the state Department of Employment and Economic Development (DEED).

At the federal level, agencies with some involvement in local economic development include the Economic Development Administration (EDA), the U.S. Department of Agriculture's (USDA) Rural Development, the Department of Housing and Urban Development (HUD) and the Small Business Administration (SBA). Distinguishing public infrastructure investments from outright business subsidies at this level can be difficult. But at the very least, federal business loan programs further supplement an extensive low-cost (sometimes no-cost) financing network.

According to a recent DEED report, about 240 Minnesota businesses took advantage of the SBA's 504 loan program and the Small Business Investment Companies program in 1997. Combined, these loans were worth almost $145 million.

Montana, with a smaller network of local organizations, and a small, widely dispersed population, depends heavily on state and federal resources to assist local business development. Through the state's Small Business Development Centers, 217 small companies received over $25 million in 1998, most of which came from the federal government.

Much of the money that states spend on economic development is pass-through money from federal sources. Montana received about $8 million in funding from HUD last year, one-third of which went to cities in the form of block grants for economic development, which typically end up as low-cost loans to local businesses.

Many local economic development professionals recognize the importance of state and federal programs in local assistance deals. Many admitted that their options would be limited—dramatically in some cases—if state and federal business assistance programs disappeared.

"We could not compete with larger communities that have the ability to throw more money at a project," said Ron Zeigler, executive director of the Lake City (Minn.) Economic Development Authority.

John Regetz, head of the Chippewa County (Wis.) Economic Development Corp., agreed. "Without state (and) federal funds we could not do the retention-expansion projects that we have (for) loyal local companies that needed help."

Other practitioners mentioned that local efforts could get by on local revolving loan funds and tax increment financing, which are used extensively throughout the Ninth District. But even here, state and federal governments play a significant role. For example, at least 80 revolving loan funds have been created in the Ninth District through the federal EDA and the USDA's Intermediary Relending Program, according to a source with the research arm of the National Association of Development Organizations.

A state report published last year found that an estimated 80 percent of the capital in all South Dakota revolving loan funds comes from state and federal sources. Businesses receiving loans through the Minnesota Investment Fund repay the first $100,000 to the local community where the business resides, which the city then typically uses as start-up or add-on capital for a local revolving loan fund. Block grants to Montana cities are used in a similar fashion.

Even tax increment financing (TIF)—the king of local development tools in Minnesota and Wisconsin—gets important, if indirect, support from the state and other local taxing districts. In a nutshell, TIF is intended to allow cities to invest in infrastructure improvements in designated areas to attract new development. As the property value of businesses located in a TIF district increases, the "new" taxes generated by the value increase go to the city to pay the capital improvement costs.

Until this infrastructure debt is repaid—which can take up to 25 years—TIF requires the local school district, county and other property-based taxing districts to forgo any additional tax revenue that they would have otherwise received from the new development, were it not for the TIF. Coming full circle, when budgets for local taxing districts increase, the state (through such things as education aid and local government aid) helps fill the gap left by taxes that were redirected to pay TIF obligations.

It might be confusing and arcane, but it's serious money for local economic development. In Minnesota, for example, multiply that example times the 1,600-odd TIF districts in the state that generated tax increments in 1998, and the result is close to $300 million in taxes that are redirected to pay off municipal bonds rather than going to the general funds of various taxing bodies.

There is also a disconnect between the intent and the practice of TIF. Designed to finance public infrastructure investments, only a small portion of TIF expenditures is used toward this goal, and most of the financial benefits accrue to a small handful of businesses, according to information reported to the Minnesota Office of the State Auditor (OSA).

For example, TIF districts in Minnesota incurred costs of $410 million in 1998 (not including $232 million worth of debt payments from TIF projects of previous years), according to the OSA. Of this total, less than 10 percent ($35 million) went for the construction of public utilities, roads or sidewalks. Almost $71 million went for land and building acquisition, which are typically resold below market value to the incoming business, according to one state expert who wished not to be identified. Another $26 million went to pay for parking facilities—a common feature in urban TIF projects—and $48 million went for site improvements, much of which a business would assume if developing outside a TIF district.

Maybe most interesting, another $70 million in TIF expenditures is simply categorized by state statute as "other," and generally considered to be direct business subsidies of one form or another, the state expert said.

A level playing field?

Although smaller towns have access to common economic development tools, that does not mean there is a level playing field, particularly when it comes to federal or state resources, several sources said.

Smaller communities have to contend with the fact that metropolitan areas like the Twin Cities typically receive more federal entitlement money, Regetz said. This can have a perverse effect, as local communities spend more on business incentives than they otherwise might. "If they (metro areas) had to come up with their own dollars, or compete for them, they would probably be more judicious," Regetz said.

Chippewa Falls County recently received a nonentitlement HUD grant of $875,000 to develop a 400-acre business park in the city of Chippewa Falls (pop. 13,000). It was the first such HUD grant for the county in probably 20 years, Regetz said, and was largely the doing of Rep. David Obey.

"We have been fortunate to have a strong representative in the U.S. House and capable staff to acquire nonentitlement federal funds, but many small communities are not so lucky," Regetz said.

As a result, "smaller communities that need assistance the most don't get more help," he said. "It's an unfair world, but readjusting the system to serve its original intent would be a better solution than eliminating the idea of helping deprived communities. Maybe putting the states in charge of the entitlement funds would help."

Related articles:

fedgazette, July 2000
Local Economic Development, Part II  

Ron Wirtz
Editor, fedgazette

Ron Wirtz is a Minneapolis Fed regional outreach director. Ron tracks current business conditions, with a focus on employment and wages, construction, real estate, consumer spending, and tourism. In this role, he networks with businesses in the Bank’s six-state region and gives frequent speeches on economic conditions. Follow him on Twitter @RonWirtz.