Energy Asset Solutions - Issues in Focus - Economic Development Incentives

Issues in Focus: Economic Development Incentives in a Time of Budgetary Constraints

By Charles R. Brettell, Principal

Energy Asset Solutions, LLC

March 2, 2010

Economic Development Incentives provide meaningful benefits to the full spectrum of stakeholders, including granting districts, residents and developers. Yet some governmental entities are withholding these important benefits citing "budgetary constraints" and a belief that these programs are little more than give-aways to businesses that "would make the investment anyway." In this installment of our "Issues in Focus" series we'll take a longer look at what Incentives are generally available to businesses, the benefits to the various constituents in the process and how Incentives impacted the investment decision-making of an EAS Client.

Read more, below.

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Economic Development Incentives can be defined as Federal, State and Local governmental grants, tax credits & abatements and alternative financing arrangements provided to developers & other businesses in an attempt to lure investment of a specific type to a specific area, usually resulting in either (or both) job creation or tax base increase. These programs can be divided into 2 main “buckets”, consisting of grants, credits & abatements (“Incentives”) in one bucket and financing programs (“Financing”) in the other. Financing programs are currently the most controversial area of governmental support. These programs include such often-vilified items as tax increment financing (TIF) and industrial revenue bonds (IRB’s). Importantly for our purposes, these are not the subject of this article.

Less controversial – and the sole subject of this piece – are those programs that provide assistance, through use of grants and tax credits & abatements, to businesses looking to expand an existing operation or locate a new facility. Grant programs vary greatly across the US, but some of the most popular programs support feasibility studies, infrastructure development, and other aspects of development that cushion the economic blow of Greenfield development (Brownfield development is usually handled under separate programs and is a discussion for another article). Tax-related programs are generally structured to return a portion of invested capital over time (usually 5 to 20 years), provide relief from increases to property taxes associated with the value of the proposed project or toll the payment of sales & use taxes during Project development. Of note here is that virtually none of these programs impact the school tax component of property taxes.

From the perspective of the business, Incentives not only defray investment costs and boost equity returns, but sometimes help fill a gap necessary to support traditional financing; as a result, they can literally be the difference between being able to do a project and having to abandon it. Often these programs are also implicit indicators to a business of the philosophy of the granting jurisdiction; that is, they are a proxy for the “business mindedness” of a community. In the business person’s mind strong incentives packages indicate an understanding that businesses make rational, return-based decisions, especially for long-lived assets like plants, factories & other capital investments, while weak or unused incentives programs indicate possible hostility to business with attendant disruption and risk, hardly the stuff of a good business investment environment.

But benefits don’t flow solely to Incentive recipients. Host site governments benefit from incentive programs in the following ways:

Job Creation – especially valuable in communities seeing population erosion based on lack of career opportunities;
Investment in the Community – at both the state & local level, investments of incentive dollars are often returned in kind or at a 100% match level by parent sponsor entities, allowing a multiple on dollars at all levels;
Platform for Growth – Incentives targeted at platform businesses (those upon which other industries can be attracted) are especially potent on a governmental return basis;
Tax Base Accretion – the promise of future tax base growth is always on the minds of the grantors, and
Civic Pride – Nothing beats good news for making people feel good about where they live (and their leaders).

Given the mutuality of benefit, it may be hard to believe – but true – that some venues are currently not utilizing existing, successful Incentives programs. The reason most often cited is that in a time of economic downturn, they can ill-afford to give away their tax dollars. Besides, they rationalize, businesses interested in development will still green-light projects in the absence of Incentives. This thinking demonstrates a fundamental misunderstanding how Incentives operate to stimulate job growth & taxes and fails to take into consideration that many businesses have options outside of their immediate area. The result is that, rather than garnering a tax revenue increase (albeit less than 100%), these jurisdictions are likely to lose the prospective investment and the jobs that could have come along with it.

A real-world example of the decision-making process for companies with geographic optionality and a portfolio of similarly profitable projects competing for scarce investment capital, played out over the last several months for one EAS Client. Here, the option was between a business investment with similar pre-Incentive returns in a Western state and another in a Southeastern location. The Western state had several state & local incentive programs on its books, including state income tax credits and local Enterprise Zone designation (which programs usually package property tax breaks & investment credits). The Southeastern venue has very similar programs, but its state income tax credit yields a double-digit present value return over 20 years. Program differences aside, the real problem was that the locality of interest in the Western state refused to grant benefits under its Incentives programs, supporting its position with the rationale that they couldn’t afford to grant benefits in a time of economic downturn. As a result, our Client’s choice was fairly clear – the Southeastern location with Incentives or the Western state without it. All things considered, this was a fairly easy decision; our client will break ground in the Southeastern location within the next 45 days.

Whatever your situation, one thing is certain. Incentives can make a material difference in the financial profile of your development or investment opportunity. As a result, it’s key that you engage someone to flesh out your options PRIOR to taking any major step in the construction phase – after all, they’re called “incentives” because they’re meant to incent you to do something you might not otherwise.

Next month we’ll talk about a fantastic non-governmental financing option that can deliver favorable terms (lower rates, longer tenor, etc.) to developers while making for outstanding returns for investors (via tax credits) & the option to piggy-back state tax credits on top!

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To learn more about how EAS can assist with your Incentives & Financing needs, click here to have one of our practice professionals personally respond to your inquiry.