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The crowded field of local economic development

April 1, 2000


The crowded field of local economic development

"Tax abatements, low-cost capital, zero-cost grants, paid workforce training and more will give your business the running start that puts you ahead of the competition. In southwest North Dakota, we will be your partners in success."

If you're not paying close attention, you might think you were reading an advertisement for a bank.

In certain ways, it is a bank ad—the Community Bank of John Q. Public, as local communities market a variety of subsidies to lure a new business to town or help an existing one expand. After the handshake, taxpayers enter the picture because that's ultimately who's footing the bill.

Neither the competition among governments for economic development nor the policy discussions it provokes are new. The Minneapolis Fed, for one, has weighed in repeatedly on the "war among the states" for big-ticket plant expansions.

But as the saying goes, everything is local, and it is particularly true for economic development. The biggest business giveaways ever negotiated by corporate suits still end up in someone's back yard, and not in someone else's. Somebody got more tax base. Somebody got more jobs. Somebody won. Somebody lost.

Better than 80 percent of business assistance agreements in Minnesota were negotiated by cities, largely because cities control land development, and real estate development remains the birth place of government-induced economic activity despite the economy's transition to an information and technology base.

Myriad evidence suggests that public involvement in local economic development is on the increase throughout the Ninth District. Yet there is surprisingly little data that might provide a snapshot of what it all looks like on the ground, how it acts or how pieces compare with each other. If there is a war going on at the local level, no one has a clue who's actually winning, how far they're ahead or why.

Nonetheless, more cities—including many with fewer than 1,000 people—zestfully enter the battle every month, using local, state and federal tax dollars to leverage subsidy deals for business. The reason is simple: Do so or forget about businesses coming to your town.

"Tax incentives are taken for granted by clients across the U.S.A., as is low-cost or free real estate," said Gaylon Baker, head of Stark Development Corp. in North Dakota.

"If you don't have the (incentive) fundamentals, you're not in the game," said John Regetz, executive director of the Chippewa County (Wis.) Economic Development Corp. Along with abatements and other common tax subsidies, Regetz said, site selectors for corporations "routinely" ask for cash incentives as well.

With an annual budget of about $85,000, Cal Klewin is charged with drumming up economic activity on behalf of the 3,500 residents of Bowman County, in southwestern North Dakota. This might not seem like much in the grand scheme of things, but Klewin said it shows commitment. Local leaders "have got to put some dollars toward the mission of growth," Klewin said. "If you look dead, you will die."

Many communities appear to agree with that sentiment. "People are jumping on the bandwagon," said Roger Nacker, director of the Wisconsin Bureau of Business Development and president of the Wisconsin Economic Development Association (WEDA). In the last few years, WEDA membership has roughly doubled to about 500. "Everybody wants to emulate the success" of other communities, Nacker said. "There are still a lot of have-nots."

The resulting creep in business subsidies is ringing up a public tab of unknown proportion. The exact total is difficult to even estimate, given the fact that there is little centralized reporting among the expansive web of public, quasi-public and nonprofit organizations brokering incentive deals on behalf of local communities.

Disparate pieces of evidence gathered in the course of research for these articles found that public expenditures on business subsidies (including tax forgiveness or avoidance) reaches hundreds of millions annually just among states in the Ninth Federal Reserve District. With more communities offering an ever-widening array of giveaways, it's a virtual smorgasbord for any expanding company willing and able to look for the best deal.

Me-too: Local activity on the rise

Larger cities have long been intimately involved in economic development activities. But smaller cities today appear eager to help bring jobs to town. Exhibit A is an increase in the number of organizations whose mission is to enhance the local economy.

Take Minnesota, for example. In 1986, the state passed legislation allowing cities to create economic development authorities (EDAs) to encourage and facilitate local business activity. By 1990, a survey found that a little fewer than 200 cities had EDAs.

A search of an online state database indicates that number has grown by upwards of 30 percent in the last decade. Maybe more surprising, it is not uncommon for cities with populations below 1,000 to have an EDA with a handful of incentive programs ready to go for an interested business. The city of Verndale, pop. 551, recently created its own EDA. It has two tax increment financing districts at its disposal and is committed to "pooling together sources of funding for prospective businesses."

In southwestern Minnesota's Renville County, 10 cities with populations of 450 to 2,600 all have EDAs. Most were created in the early to mid-1990s to better facilitate economic and housing activities in each city, according to Julie Rath, director of the Renville County Economic Development Commission, which helps coordinate activity among the cities.

That organizational network for local economic development also extends well beyond city hall. At least two dozen counties in Minnesota have formal EDAs, and some 40-plus quasi-public and private nonprofit organizations were identified whose mission involved economic development on behalf of cities or regions. Even among cities with no formal EDA, some still manage to have basic business incentives on the table.

In some states, the network of local development organizations has been largely in place for years, but has become more active of late. For example, there are 166 local development corporations recognized in South Dakota. That number has gone up by not more than about 10 percent during the last seven years, estimated Connie Halverson, manager of business and community development for the Governor's Office of Economic Development.

The Eureka Community Development Corp. (ECDC) in Eureka, S.D., has been around since 1960, but "has been very active in the last 10 years," according to Wanda Jundt, the group's secretary. Representing a city population of just 1,200, ECDC's staff of two part-time employees, including Jundt, might seem exorbitant. But its size and off-the-beaten-path location in north-central South Dakota is actually part of the justification for two paid staff.

"It is hard to find business even interested in looking at our town, and much harder to convince them to locate here," Jundt said. In the last year, one new business has come to town, replacing a company that had moved out of the country.

"The ones we have worked with would not have located in Eureka without the financial assistance" coordinated through the ECDC, Jundt said. "With a poor ag economy, these jobs are extremely essential to the economy of the town."

Montana has a fairly small number of local development organizations—one source put the number at 60 to 65 groups—but the state is home to only 50 cities and 78 townships. Local efforts to spur growth "is probably among the hottest topics in the state now," according to Tod Kasten, regional development officer for the state's eastern region. People are looking for ways to increase resources in economic development, and candidates for elected office are running on "jobs and income kinds of platforms," Kasten said. "It's highly debated how to fund such efforts."

Table-MT spending on business development programs

Local demand for funding from state programs has also been strong, according to Gary Morehouse, financial program director with the Montana Department of Commerce. "The demand is way stronger than what we have available," Morehouse said. With more groups seeking assistance from a fairly small pool of state resources, existing programs "just run out quicker ... the bulk of the money is out in a couple of months. There is a huge need for more," Morehouse said.

Last year, the Montana Legislature responded by approving $10 million for a string of new economic development programs. The funding mechanism—diverting money from an existing coal tax—was found unconstitutional, and a special session will convene in May to find an alternative funding source.

Locals set their own table of incentives

Rising interest rates are also fueling inquiries to local, low-cost loan programs. Evan Barrett, executive director of the Butte (Mont.) Local Development Corp., (BLDC) said many banks have pushed their commercial loans to 10 percent or more and BLDC loans "now are becoming very attractive at 6 percent."

Evidence indicates there are literally hundreds of such low-cost loan programs in Ninth District communities—BLDC itself administers six. Most are revolving loan funds, a mechanism whereby businesses receive loans at below-market interest rates, and subsequent repayments are then lent or "revolved" to other businesses.

In Minnesota, there were virtually no revolving loan programs before 1984. By 1989, there were 157; seven years later, the number had grown to 237, according to a legislative auditor's report. Total capital in these revolving loan funds more than doubled to $110 million from 1989 to 1996.

In South Dakota, $132 million in capital is available from 84 revolving loan funds through 69 organizations statewide, according to a joint state report. Three of four loan funds have opened for business since 1989.

The use of tax increment financing (TIF)—a standby tool for many communities—is also rising steadily in some states. TIF allows cities to upgrade infrastructure in designated areas and use the new or "increment" property taxes to pay the costs.

In Minnesota, for example, TIF is used in more than two of five business assistance agreements. In 1998, the Department of Revenue reported that more than 400 TIF authorities (mostly cities) had over 1,600 revenue-generating TIFs-an increase of more than 100 such districts from just one year earlier. (The Office of the State Auditor identified over 2,000 total TIF districts in the state in 1998, which included recently established and underperforming TIFs that generated no increment revenue.)

Table-Distribution of assistance agreements in MN

The city of Spicer, about 100 miles directly west of the Twin Cities with a population of 1,167, boasts seven TIF districts. It is hardly alone among small Minnesota cities, as about one of three cities with a population between 200 and 2,500 reported TIF revenue in 1997.

Among the 26 Wisconsin counties in the Ninth District, currently there are 75 cities with 146 tax increment districts. Since 1990, the area has seen a net creation of 33 new TIF districts.

Along with a traditional TIF program, Montana has a separate TIF used specifically for industrial development (TIFID). The city of Butte has 1,300 acres in two TIFIDs, and the program was recently used to finance $50 million in infrastructure expansion and upgrades to support a new $500 million expansion by Advanced Silicon Materials, which will employ 200 people.

"We've been preaching it (TIFID) for 10 years," Barrett said. "It's just starting to get used."

With different needs in different communities, oftentimes the most useful tool for local communities—at least those with resources—is the ability and relative autonomy to customize an incentive package.

"I think some of the locals (programs) are far more creative" in designing programs that meet specific needs of the business and the local community, said Nacker of WEDA. As a result, businesses can negotiate for a host of local incentives, from site amenities to buy-downs on land, interest and utility costs, or even lawyer fees.

In Douglas County, Wis., five local development organizations sponsor an annual "best business plan" contest, with winners receiving small cash awards and a $5,000 to $10,000 zero-interest loan.

An economic development group in Montana was reported to have guaranteed a communications company 1,500 lines at $1,000 each to expand their business in the local community. Commissioners for Stark County, N.D., rezoned a 41-acre tract and froze property taxes for five years.

Public and private development corporations in Gogebic County (U.P.) have underwritten spec buildings with generous lease options due to a shortage of available industrial and commercial buildings, according to a local source. Last year, the Pierre (S.D.) Economic Development Corp. built a 30,000 square-foot facility for $1.2 million, which it leased to an electronics company.

Grand Forks, N.D., spent $2.25 million to purchase and upgrade 77 acres of land with the hope that would build a new distribution center on the site. It didn't, and had never really planned to, according to local reports.

A million pennies

With more cities looking to get their share of the business pie, getting a handle on what's actually spent or given out in a particular year is difficult to determine with any certainty.

Minnesota collects far and away the most information regarding business subsidies. In other Ninth District states, data on local economic development spending is nothing more than a handful of disparate facts collected by different agencies.

Minnesota first passed a reporting law in 1995, but later repealed and replaced it with a tougher law requiring all organizations with the authority to provide a business subsidy to report any agreements that were worth more than $25,000 or included TIF. The law remains one of only two in the country (Maine has the other).

From 1995 to 1998, 123 organizations reported entering into 467 agreements, which rang up a public tab of $138 million last year alone. Burnsville, a fast-growing suburb in Dakota County, made 45 separate agreements during this period (virtually all of it TIF) which provided businesses with $15 million in assistance last year.

A pioneering law, it nonetheless provides only a glimpse of what's given to businesses. For one, the law cannot factor in the ongoing costs of assistance agreements made before 1995—from which TIF alone would add a couple of hundred million dollars to last year's price tag.

Beyond these formal agreements, significant resources also are spent under the larger umbrella of "economic development." For example, Minnesota counties spent $80 million on economic development from 1995 to 1998, according to the Office of the State Auditor. Minnesota's reporting law, however, found that counties made just $1 million worth of business agreements during this time. Whether the remaining $79 million was spent on public infrastructure for the benefit of the larger community is difficult to determine with any certainty.

Examples from other states show that local communities are getting access to more resources to promote economic development. In North Dakota, for example, cities are allowed to add up to 1 cent onto the state's sales tax. One state official said that probably fewer than 10 cities collected any such sales tax a decade ago. But last year, 75 cities collected a local sales tax, and better than eight of 10 dedicated some or all of this revenue specifically to local economic development, according to figures from the Office of the State Tax Commissioner.

Minot, N.D., is one of those cities that recently enacted the local sales tax. Four-tenths of a cent is added to every dollar of sales in the city and dedicated to economic development activities. That might not sound like much, but it rings up about $1.7 million annually for the city, and contributed significantly to a recent subsidy package of almost $11 million for Northwest Airlines to relocate its customer service center and 600 jobs from Plymouth, Minn.

Cities and counties in North Dakota are also allowed to levy an additional mil onto property taxes to specifically fund economic development activities through a joint development authority. Last year, 20 cities levied the additional tax, although only two generated more than $10,000. In contrast, 30 counties collected almost $2 million through the additional mil for economic development activities, with three counties raising over $100,000.

Cities in South Dakota have a similar opportunity to tack on a local sales tax, and currently 116 communities do so, according to Halverson, but no one tracks how much the tax generates statewide or how the money is spent.

Local communities in Montana have two unique tools at their disposal. One is the ability of cities to create port authorities regardless of whether there is any port activity. This authority enables communities to levy an additional two mils onto local property taxes for port activities, and if there are none, the money can be used for economic development.

"It's an open door for any local government to use the auspices of a port to generate money for economic development as long as they don't have to use it for transportation activities," Barrett said. To date, the cities of Billings, Great Falls and Kalispell have levied the two additional mils for this purpose, generating between $100,000 and $400,000 a year for local economic development in each city, Barrett said. Ravalli County, located on the western edge of the state, created the first county port authority last year, according to Morehouse.

A second law allows cities and counties to levy one mil specifically to fund economic development efforts—but it must be approved by voters. In the state's history, voters have approved such a levy increase only three times, twice in Butte and once in Beaverhead County, Barrett said.

"It's very difficult to get people to vote for a tax on themselves," Barrett said. But a recent change in law gives government bodies the power to add the mil without constituent approval. The trade-off is that the mil must be reapproved every year, rather than every six years if approved through a voter referendum.

Adding it up

With so little comprehensive data available on local economic development and business subsidies, evaluating the impact of such activities can be difficult, maybe sometimes conveniently so.

"How do you measure a return on something that doesn't presently exist?" said Jerry Thomas, head of the Big Sky Economic Development Authority in Billings, Mont. "The new or expanding business activity that does generate new taxes on jobs and properties, because of our incentives, is a new net gain."

Among the two dozen or so local development officials who commented for this story, few saw the need for rigorous evaluation of business incentives so long as companies passed a basic smell test for jobs, which itself can be a moving target.

"The public's return is having jobs locally where they can make a decent wage with benefits," said Jundt of Eureka.

James Hill, executive director of the La Crosse (Wis.) Area Development Corp., said performance measures are becoming more prevalent in incentive deals, but added that "most probably just weigh it on a situational basis."

"There is no way you can establish cause and effect on these things," said Nacker of WEDA. "If it achieves mutual goals (for the company and community), it serves its purpose."

Several sources admitted that at least some of the private investment would likely still occur without the assistance. But the subjective nature of "good vs. bad" investment of public resources makes a formulaic analysis of such incentives difficult, if not impossible, according to several officials.

"It's hard to measure (performance). It becomes an awful lot of gut feeling," said Jack Sroka, executive director of the Barron County (Wis.) Economic Development Corp. "I don't know that we can ever get there (having tangible performance criteria). That if it meets this, this and this, it's good."

Community circumstances have to be considered, which can change the bottom line of a particular proposal, according to Ron Kraft, executive director of the Yankton (S.D.) Office of Economic Development. Suppose, for instance, "your community just lost an employer that employed 850 people in a rural community. You will do more (to land a prospective employer) following that hit than you might when all your employers are growing and hiring," he said. Sroka acknowledged that in some instances, local officials are enamored with the idea of simply bringing new jobs to town, regardless of the ultimate cost. "I think there's a lot of that," Sroka said.

Others agreed. "I do see incentives handed out where the benefits back to the community are not evident," said Steve King, executive director of the Dakota County (Minn.) Economic Development Partnership. Community incentive programs are "all over the map. It's not properly focused at all," King said. "There isn't someone to help cities drink from the cup of reason."

Kasten, the Montana regional rep, said some agreements are "dumb-risk lending" where sometimes "the bottom-line is they don't pay." A former banker, Kasten said he has sat in on public loan proposals that didn't make financial sense but were nonetheless approved.

"There is a reason banks are tight with their money," Kasten said. "You have to be careful you're not buying jobs."

Many incentive deals now come with "clawbacks"—repayment of subsidies if certain goals aren't met. But there has been little analysis on the net effect of clawbacks, such as how often clawback provisions have been triggered and ultimately recouped, or whether clawback standards are appropriately high, rather than set artificially low to avoid being triggered.

Here comes the sun?

With a multitude of factors to consider—not the least of which is a difference of opinion about what constitutes success and failure—public scrutiny might play an important role in the future popularity of business incentive agreements.

The intent of the Minnesota reporting law "is to provide some sunshine" to business assistance agreements, according to Bob Isaacson, director of the Office of Analysis and Information in the state Department of Employment and Economic Development (DEED).

"What we're doing is trying to provide some accountability for taxpayers," Isaacson said. Local communities should be left alone to set their own subsidy objectives, because they better understand the unique needs and local context for economic development, Isaacson said. But some form of standard was also critical, along with the need to objectively measure performance.

"I think you can measure it (performance)," Isaacson said. "It's only right as a government office that we seek some kind of return on investment ... (and) to be sure we're spending tax money wisely."

Widely heralded throughout the country, however, the law has no regulatory consequences for suspect agreements. Isaacson acknowledged that neither DEED nor any other state department had much recourse for cities entering into suspect agreements. "They can do whatever they want, in reality."

As a result, the law's only real leverage is through public scrutiny. Along with an annual report on the number and type of agreements entered, the law requires public hearings prior to any final contract. Unfortunately, the public's interest in these hearings to date has been minimal, Isaacson said.

"There's a lot of sunshine, but I'm wondering how many people seek the sunshine," Isaacson said. "I'm not seeing the interest in it I'd like to see. ... They (citizens) don't take the time to find out where tax money is going."

One of the reasons might be that local citizens simply want to see their communities grow, and don't care to consider wonkish cost-benefit analyses, or the larger effects of communities battling each other for economic growth.

When residents "see people moving into this area to fill jobs that are created by new businesses and existing businesses, they are happy. They are not really concerned with the fact that this growth could have occurred in some other area of the country and the net effect on the (gross national product) for the country would be the same," said Dan Scott, president of the Sioux Falls (S.D.) Development Foundation.

So many communities see the apparent rewards of business assistance programs that "the marketplace has evolved to include incentives," according to Jerry Murphy, head of the Gogebic County (U.P.) Economic Development Corp.

Incentives by themselves rarely make or break a deal, "but they can eliminate contending locations from the competition if they are not in balance" with the rest of the market, Murphy said. "Attempting to reverse that trend with national or international economic logic is an interesting debate for economists, but hardly practical at a community level."

For more information on the Minneapolis Fed's work on this issue, see Arthur Rolnick and Melvin Burstein, "Congress Should End the Economic War Among the States", The Region, March 1995; see also a special June 1996 issue of The Region that reported on the proceedings of "The Economic War Among the States," a conference held in Washington, D.C., on May 21-22, 1996. Other resources on this topic can be found at Special Studies: The Economic War Among the States.

Related articles:

fedgazette, July 2000
Local Economic Development, Part II


photo of Ronald A. Wirtz
Ronald A. Wirtz
Editor, fedgazette

Ron Wirtz is a regional outreach director at the Federal Reserve Bank of Minneapolis. Ron’s primary responsibilities involve tracking current business conditions, with a focus on employment and wages, along with sector-tracking in construction, real estate, consumer spending and tourism. In this role, Ron networks with local businesses in a six-state region, both in person and via various communication channels, and gathers other traditional and nontraditional sources of information to assess current business activity. Ron also gives customized speeches on regional economic activity, and handles advance planning for regular outreach trips to Ninth District communities by Bank President Neel Kashkari. Prior to this role, Ron was the long-time editor of the fedgazette, the Bank’s regional business and economics publication, where he conducted research on such topics as employment trends, health care pricing and consolidation, housing, entrepreneurship, public pensions, income mobility, the Bakken oil boom and other topics.