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238 cities are wooing Amazon. The winner may end up with a very bad deal.

- October 24, 2017

States and cities often pay a lot of money to attract businesses. For example, 238 city governments submitted bids to attract a second Amazon headquarters, in many cases offering hundreds of millions or billions of dollars in incentives. One small town in Georgia is even offering to rename itself in honor of the company.

However, these deals are often controversial. People have asked whether economic development agreements like those that brought Carrier to Indiana and Foxconn to Wisconsin are good value for money.

Here’s how I did my research

So what does social science have to say? In general, research shows that roughly two-thirds of incentives are given to companies that were going to move to a state regardless of whether the company received a tax break. There are also more specific issues. I conducted an analysis of one of the largest — and most controversial — Texas economic development programs and found that companies save millions of dollars through a provision called Chapter 313, at the expense of local taxpayers. This study reveals that companies often don’t need support to locate in Texas. Furthermore, they pool money from multiple programs to vastly increase their benefits.

In general, the evidence strongly suggests that Chapter 313 leads to a transfer of wealth from Texas taxpayers to firms.

Even dubious investments can get funded

The justification for tax incentives is supposed to be that it attracts businesses that would otherwise not invest in a particular state or location. However, that isn’t how it works in practice. In some cases, companies had started to build their operations before they applied for incentives (see this YouTube video of a Caterpillar plant breaking ground). For example, FAA data shows both when the wind farms were constructed and when they applied for incentives that were supposed to attract them to locate their business there. In a number of cases, wind farms were constructed before they applied for incentives. One company applied for their incentives three years after building their wind farm!

In other cases I discuss in my research, companies admitted in their application that they were not considering other locations. These applications are submitted by school districts and verified by the Texas comptroller. The first applicant in the program, Dow Chemical, admitted that it had begun construction before it applied to the program. Other companies said that they were only considering building in other cities in Texas, suggesting that the state didn’t need to provide any incentives to get them to locate there.

It is striking that government officials were able to see that the program wasn’t working as it should. The Texas comptroller’s documents that certify many of these programs often note some of the evidence that companies were applying for incentives after they had already built.

School boards have perverse incentives to support these agreements

In many states, school districts oppose agreements that offer tax incentives. After all, these school districts need local tax revenue to pay their bills. In Texas, however, things are different. Texas’s Chapter 313 program limits property taxes to attract businesses to Texas locations. This program looks to “make whole” local school districts, by ensuring that any tax benefits given to companies are refunded by the state. On top of this, schools can request “supplemental payments” from the companies, in exchange for supporting economic deals.

What does this mean in practice? When the companies receive state-funded tax breaks, local school districts can request a cut of the incentive payments, which amount to up to 40 percent of the company’s tax benefits. Thus, school districts actually end up better off if they give away a tax incentive to companies.

This point isn’t lost on the consultants pitching these programs to school districts. A recent presentation by consultants on the value of Exxon to a community shows that providing a 313 agreement, even if it isn’t necessary, is good business for the school district.

Consultants get their cut on both sides of the negotiations

A minor industry facilitates the transactions between school boards and companies that allow these deals to take place. When I reviewed almost 300 applications for the Texas Chapter 313 program, a few consultants’ names came up repeatedly, appearing on both sides of the bargaining table. The incentive program requires company applicants to pay a $75,000 fee, which school districts can use to pay for consultants to bargain on their behalf. In one example, a school superintendent moonlighted as a consultant.

Companies also use their own consultants, and many of these firms use “performance based payments,” where the consultancies get a percentage of all incentives. When California attempted to ban this form of payment, Texas tax consultant Ryan LLC sued the state.

We don’t know much about confidential agreements between firms and consultants, but data on the transfer of incentives reveals that a major market exists for buying and selling tax credits. Many of the taxpayer dollars used to encourage investment are siphoned off in the process of applying, negotiating, and trading incentives.

Companies claim multiple tax incentives or exemptions

Firms collect incentives from multiple programs, including grants at the state and local level, as well as tax exemptions. Few firms advertise the many incentive programs they are drawing from in public. However, many applications for the Texas Chapter 313 program list these incentives that companies are getting or looking for.

One example is Maverick Tube’s 2013 application for a new plant in Van Vleck, Tex. Under this program, the local school board and Texas comptroller approved a 313 agreement. This saved the company millions by taxing the investment at the value of $10 million instead of the $1.15 billion value of the proposed investment. However, 313 is only one incentive, and at the end of the application, the company pasted in an Excel spreadsheet that lists a total of $449.5 million in incentives. This includes tax abatements spanning as long as 45 years and grants from numerous sources. The Chapter 313 program incentives, often seen as one of the most generous programs, accounted for only 22 percent of the incentives.

Unfortunately, economic evaluations of incentive programs, including Chapter 313, often focus on only one incentive and ignore the others. Maverick Tube proposed creating 600 jobs at a cost of $153,000, if we only look at the 313 program. However, if we include the costs of all of the other subsidies, the cost to the taxpayer is a remarkable $732,500 per job. And that is assuming that this program actually brought the company to Texas.

In Wisconsin, Racine County’s recent offer of $768 million in incentives for a $10 billion Foxconn plant is another example. In the county’s justification and analysis of this incentive, it claims that this incentive involves $11 of private investment for every one public dollar. Unfortunately, this ignores the almost $3 billion in incentives from the state.

It may be that deals to entice investment work better in other settings than Texas (although the academic literature is frankly skeptical about this set of measures). What we can say is that in Texas, these incentives very often don’t appear to do what they are supposed to do. Very often, they seem to provide money to companies that would want to invest in Texas anyway. The sums involved are sometimes staggeringly large, and unsurprisingly, this has created a cottage industry of political consultants, who look to broker deals in which businesses and local school boards can get large amounts of money from the state.

Nathan M. Jensen is a professor of government at the University of Texas at Austin.