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Taxes, Incentives and Economic Development © Allen C. Goodman 2015 1 Taxes, Incentives and Economic Development © Allen C. Goodman 2015 1

Taxes are a Cost of Doing Business • Let’s start with a spreadsheet. • Taxes are a Cost of Doing Business • Let’s start with a spreadsheet. • Simple Firm • Could locate at A or at B. • Only difference is property tax rate. 2

Taxes are a Cost of Doing Business • What are the net impacts? • Taxes are a Cost of Doing Business • What are the net impacts? • What do these tell us? 3

This leads to lots of questions • Are local taxes the only determinants? • This leads to lots of questions • Are local taxes the only determinants? • Do they impact current residents? • Do they impact movers? • What do the taxes buy? 4

In the early 1980 s GM Built Saturn Plant • They could locate anywhere. In the early 1980 s GM Built Saturn Plant • They could locate anywhere. Why did they locate in Spring Hill TN? • Bartik and colleagues looked at – transport costs – labor costs for local suppliers – state and local taxes (before subsidy) – total costs 5

Estimated Location related Cost ($/car) City • • Nashville, TN Lexington, KY St. Louis, Estimated Location related Cost ($/car) City • • Nashville, TN Lexington, KY St. Louis, MO B’ton, IL Kalamazoo, MI Terre H, IN Marysville, OH Transport • 426 • 423 Local Labor • 159 • 186 State, Loc Tx • 118 • 106 Total • 703 • 715 • • • 419 417 430 • • • 172 202 244 • • • 134 162 116 • • • 725 781 790 • • 413 427 • • 209 219 • • 168 169 • • 790 815 6

Wages were considerably HIGHER! Estimated Cost ($/car) City • • Nashville, TN Lexington, KY Wages were considerably HIGHER! Estimated Cost ($/car) City • • Nashville, TN Lexington, KY St. Louis, MO B’ton, IL Kalamazoo, MI Terre H, IN Marysville, OH Transport • 426 • 423 Local Labor • 159 • 186 State, Loc Tx • 118 • 106 Total • 703 • 715 • • • 419 417 430 • • • 172 202 244 • • • 134 162 116 • • • 725 781 790 • • 413 427 • • 209 219 • • 168 169 • • 790 815 Kalamazoo – Nashville = 87 State and local taxes were LOWER in Kalamazoo than in Nashville 7

What Ec Dev Incentives are in US? • General Idea: Reduce costs to business What Ec Dev Incentives are in US? • General Idea: Reduce costs to business of locating in a certain place. • One idea is property tax reduction – we’ve looked a little at that. • Another idea is to subsidize borrowing of business who locate and/or expand in the locality. • How do these work? 8

What Ec Dev Incentives are in US? • General Idea: State or local government What Ec Dev Incentives are in US? • General Idea: State or local government issues bonds. Revenue stream from a private project pays the interest. • Because interest from municipal bonds is not taxable (a conscious choice of our federal system), the private business can borrow at a lower interest rate. • How does this work? 9

Look at demand supply of credit r = interest rate • Consider a bunch Look at demand supply of credit r = interest rate • Consider a bunch of corporate borrowers. • You have supply and demand for credit. • Lenders are suppliers of credit! • Suppose that owners of state and municipal bonds do not have to pay interest on their bonds. S D r 0 Interest Payments B 0 10 Volume of B

Look at demand supply of credit • Lenders would love to get r 0 Look at demand supply of credit • Lenders would love to get r 0 and not have to pay taxes. • But, if they were willing to lend at r 0 and pay income taxes (e. g. 28%), they would be willing to accept r 1 which is slightly higher than 0. 72 * r 0. • Why? Because r 1 > 0. 72 r 0. r D S S' r 0 r 1 11 B 0 B 1 Volume of B

Who buys these bonds? • Suppose you have rich and poor lenders r D Who buys these bonds? • Suppose you have rich and poor lenders r D S S' – Rich are in 28% tax bracket – Poor are in 15% tax bracket • Consider a $10, 000 bond that would pay 6% taxable interest. • Annual interest payment to lender is $600. • After-tax payment for – Rich = 0. 72* 600 = $432. – Poor = 0. 85* 600 = $510 r 1 12 B 0 B 1 Volume of B

Who buys these bonds? • If the interest rate fell to 5. 10%, this Who buys these bonds? • If the interest rate fell to 5. 10%, this would be the equivalent of 5. 10/0. 72 for the rich, or 7. 083%. • Since this is bigger than 6%, more money would come in r r 0 r 1 D S S ' ' S' 5. 10 4. 32 13 B 0 B 1 Volume of B

Who buys these bonds? • We saw that the rich are r better off Who buys these bonds? • We saw that the rich are r better off buying the bond if the yield is very slightly more than 0. 72 * r 0, or 0. 72 * 6% = 4. 32% r 0= 6. 00% • They are the MARGINAL borrowers, and they r 1= 4. 32% determine the differential return. • Any poor person who buys this tax-free bond would be better off buying a taxable bond and paying the taxes. D S S' 14 B 0 B 1 Volume of B

Who buys these bonds? • Any poor person who r buys this tax-free bond Who buys these bonds? • Any poor person who r buys this tax-free bond would be better off buying a taxable bond and paying the r = 6. 00% taxes. • Why? Because s/he r = 4. 32% is earning 4. 32% • If s/he bought a taxable 6% bond . 85*6% = 5. 10% D S S' 0 1 15 B 0 B 1 Volume of B

This is CAPITALIZATION • We learned that capitalization is a “demand side” adjustment. Where’s This is CAPITALIZATION • We learned that capitalization is a “demand side” adjustment. Where’s the demand? • Well … it is the demand for the BONDS, that increases their price, lowering the return. • This comes out as an increase in the SUPPLY of credit.

What does this have to do w/ ED, that is Economic Development? • It What does this have to do w/ ED, that is Economic Development? • It allows firms to borrow money at lower costs. • Tax breaks only help activities that pay taxes. Just about everyone borrows money. • If a firm can borrow at a lower interest rate, the firm will increase its profits. 17

Tax Abatements • They take the form of credits (pay less), abatements (don’t pay), Tax Abatements • They take the form of credits (pay less), abatements (don’t pay), and special treatments. • One way or another, they reduce the costs of doing business within the boundaries of the particular jurisdiction (either state or local). • Issues – Do they work? – If taxes are lowered, and you need services, who pays the taxes? 18

Excise effects Mieszkowski’s EXCISE tax effect. • Within a metropolitan area, property taxes are Excise effects Mieszkowski’s EXCISE tax effect. • Within a metropolitan area, property taxes are a cost of doing business. • If the ABC Co. (currently located on the planet Venus) goes to Southfield and says, “we have a $10, 000 project, and the property taxes in Southfield would be 2% of $10, 000 or $200, 000 per year. We’re indifferent between you and Warren. If you give us a 50% property tax abatement we’ll locate in Southfield. ” • Suppose, now that they go to Warren and they say the same thing. • What happens? 19

Excise effects • What are things to ask? – Is ABC really indifferent between Excise effects • What are things to ask? – Is ABC really indifferent between Southfield and Warren? Why or why not would they be? – What are the benefits and costs to Southfield and Warren of foregoing $100, 000 per year in taxes? – What about the businesses that are already in Southfield (or Warren)? Are they being treated the same way? Should they be treated the same way? – Would it be better for Southfield and Warren to get together and stand firm against the tax competition? 20

Michigan Film Tax Credit • Michigan's film incentives were used as Michigan Film Tax Credit • Michigan's film incentives were used as "refundable tax credits. " That means a production company awarded a credit got to write off all of its Michigan business tax, which is typically a tiny portion of the credit that can run into the millions of dollars. • The state then cut a check for the balance and pays the filmmaker. Many other states competing for films also used refundable credits. California does not. http: //www. freep. com/article/20110306/BUSINESS 06/110305028/Guide-How-Michigan-s-film-incentive-program-works

How companies get incentives 1. The Film Office and the Michigan Treasury Department reviewed How companies get incentives 1. The Film Office and the Michigan Treasury Department reviewed the application of a company that intends to spend at least $50, 000 in Michigan to qualify for the tax incentive. The review generally takes about four weeks. 2. The Film Office and Treasury approves or denies the application. Production-related spending in any of 136 core communities, such as Detroit, Grand Rapids and Flint, were eligible for a 42% tax credit. Spending in other communities, such as Plymouth, Grosse Pointe and Birmingham, were eligible for a 40% credit.

3. The company wraps filming on the movie, usually after about three months in 3. The company wraps filming on the movie, usually after about three months in Michigan. 4. The company’s accountants compile all productionrelated spending in Michigan at restaurants, hotels, hardware stores, caterers, retailers, etc. They submit an audited copy of expenses to the Film Office. The company requests a postproduction certificate from the Film Office.

Giving Refunds on the Expenses! 5. The Film Office and Department of Treasury reviewed Giving Refunds on the Expenses! 5. The Film Office and Department of Treasury reviewed the expenses. The Film Office issues a postproduction certificate to the company. That certificate lists the tax credit owed to the company. 6. The company files a Michigan Business Tax return at the end of its tax year. The company uses the incentive to reduce its Michigan taxes, which are usually minimal. The state sends the company a check for the balance of the incentive.

So … why is this bad? • Because it gives incentives for spending, not So … why is this bad? • Because it gives incentives for spending, not for profitability. • Suppose a business, spends $100, and sells for $100. • We turn around and write them a check for $42. • More they spend, bigger the CHECK. 25

Economics • Would these firms come here otherwise? • On net, are we bringing Economics • Would these firms come here otherwise? • On net, are we bringing in more tax revenue than we are giving away? • Is directing aid to these businesses better policy than directing the aid to others?

Answer • When the Snyder administration drastically reduced the incentives, movie-makers stopped coming. • Answer • When the Snyder administration drastically reduced the incentives, movie-makers stopped coming. • Spin-off effects were drastically overstated. • Cities like Allen Park got totally conned, and went bankrupt supporting projects. • Look at description. http: //www. bloomberg. com/bw/articles/201208 -23/the-movie-flop-that-sank-a-michigantown

The results • The bond sale—now under investigation by the U. S. Securities and The results • The bond sale—now under investigation by the U. S. Securities and Exchange Commission—doubled the city’s long-term debt, and the annual bond payments of $2. 6 million are draining its $20 million general fund. • The city officials who approved the deal all stepped down or were voted out of office. • Voters have twice rejected property-tax increases to pay off the bonds.

Is it a prisoner’s dilemma? TS, TW are tax receipts in Southfield and Warren Is it a prisoner’s dilemma? TS, TW are tax receipts in Southfield and Warren • Do we give Warren 50% tax No abatement? • In boxes we have total expected tax Yes receipts for the municipalities. Southfield No TS = 2 M TW = 2 M TS = 0. 5 M TW = 2. 5 M Yes TS = 2. 5 M TW = 0. 5 M TS = 1 M TW = 1 M 29

Is it a prisoner’s dilemma Southfield No • Let’s look at dominant strategies. Warren Is it a prisoner’s dilemma Southfield No • Let’s look at dominant strategies. Warren No TS = 2 M TW = 2 M Yes TS = 0. 5 M TW = 2. 5 M • Southfield? Abate! Why? • Warren? Abate! Why? Yes TS = 2. 5 M TW = 0. 5 M TS = 1 M TW = 1 M 30

Is it a prisoner’s dilemma Southfield No • Under these Warren circumstances, competition is Is it a prisoner’s dilemma Southfield No • Under these Warren circumstances, competition is No certainly not optimal for particular cities. TS = 2 M TW = 2 M Yes TS = 2. 5 M TW = 0. 5 M • Cooperation would be better. Why? • All of this depends on what’s in the boxes. Yes TS = 0. 5 M TW = 2. 5 M TS = 1 M TW = 1 M 31

Effects of Taxes and Public Services • Do property taxes and public services make Effects of Taxes and Public Services • Do property taxes and public services make a difference. • Example: – Business wants to open. Has its choice between City D, with high property taxes, and – City E, with low property taxes. • Do these taxes make a difference? 32

Effects of Taxes and Public Services • Solid evidence that, all else equal, local Effects of Taxes and Public Services • Solid evidence that, all else equal, local taxes have strong negative effects on local business growth. Why? • What does the all else equal mean? A> It depends what the people who levy the taxes are doing with the money they raise. 33