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Location-based programs that provide tax credits to firms and investors that locate in particular areas are popular among politicians of both parties. Democrats tend to support them because they are meant to revitalize poorer or rural areas. In a recent speech about the economy, presumed Democratic nominee Hillary Clinton spoke favorably about two of them: the New Markets Tax Credit Program and Empowerment Zones.

Some Republicans also support such programs, which they view as being a pro-business way to help low-income communities. However, House Speaker Paul Ryan’s recent tax reform blueprint generally disapproves of tax credit programs.

Due to the volume of location-based programs and their relatively narrow objectives, many taxpayers are unfamiliar with their differences or unaware that they even exist. This is to be expected since most people are never directly affected by one. In this post I explain one that Hillary Clinton recently spoke about, the New Markets Tax Credit (NMTC) program.

The NMTC program was created in 2000 as part of the Community Renewal Tax Relief Act. It is managed by the Community Development Financial Institutions Fund, which is a division of the U.S. Treasury Department.

The NMTC program provides both new and established businesses with a tax credit that can be used to offset the costs of new capital investment or hiring new workers. The goal is to increase investment in low income communities (LIC) in order to improve the economic outcomes of residents.

Even though the program was started in 2000, no funds were issued to investors until 2003 (although some funds were allocated to the program in 2001 and 2002). Since 2001 over $43 billion has been allocated to the program. The figure below shows the allocations by year, amount issued to investors, and the total amount allocated from 2001 – 2014 (orange bar, uses right axis).

NMTC allocations Figure 1

Practically all of the allocated funds from 2001 to 2012 have been issued to investors. A little over $250 million remains from 2013 and $1.3 billion from 2014. As the figure makes clear, this program controls a non-trivial amount of money.

The types of projects funded by the NMTC program can be seen in the figure below. The data for this figure comes from a 2013 Urban Institute report.

NMTC projects funded Figure 2

So what have taxpayers gotten for their money? The program’s ‘fact sheet’ asserts that since 2003 the program has

“…created or retained an estimated 197,585 jobs. It has also supported the construction of 32.4 million square feet of manufacturing space, 74.8 million square feet of office space, and 57.5 million square feet of retail space.”

Like many government program administrators, those running the NMTC program seem to confuse outputs with outcomes. Presumably the goal of the NMTC program is not to build office space, which is a trivial achievement, but to improve the lives of the people living in low income communities. In fact, the program’s fact sheet also states that

“Investments made through the NMTC Program are used to finance businesses, breathing new life into neglected, underserved low-income communities.”

What really matters is whether the program has succeeded at “breathing new life” into LICs. To answer this more complicated question one needs to examine the actual economic outcomes in areas receiving the credits in order to determine whether they have improved relative to areas that haven’t received the credits. Such an exercise is not the same thing as simply reporting the amount of new office space.

That being said, even the simpler task of measuring new office space or counting new jobs is harder than it first appears. It’s important for program evaluators and the taxpayers who fund the program to be aware of the reasons that either result could be speciously assigned to the tax credit.

First, the office space or jobs might have been added regardless of the tax credit. Firms choose locations for a variety of reasons and it’s possible that a particular firm would locate in a particular low income community regardless of the availability of a tax credit. This could happen for economic reasons—the firm is attracted by the low price of space or the location is near an important supplier—or the location has sentimental value e.g. the firm owner is from the neighborhood.

A second reason is that the firms that locate or expand in the community might do so at the expense of other firms that would have located there absent the tax credit. For example, suppose the tax credit attracts a hotel owner who due to the credit finds it worthwhile to build a hotel in the neighborhood, and that this prevents a retail store owner from locating on the same plot of land, even though she would have done so without a credit.

The tax credit may also mistakenly appear to be beneficial if all it does is reallocate investment from one community to another. Not all communities are eligible for these tax credits. If a firm was going to locate in a neighboring community that wasn’t eligible but then switched to the eligible community upon finding out about the tax credit then no new investment was created in the city, it was simply shifted around. In this scenario one community benefits at the expense of another due to the availability of the tax credit.

A new study examines the NMTC program in order to determine whether it has resulted in new employment or new businesses in eligible communities. It uses census tract data from 2002 – 2006. In order to qualify for NMTCs, a census tract’s median family income must be 80% or less of its state’s median family income or the poverty rate of the tract must be over 20%. (There are two other population criteria that were added in 2004, but according to the study 98% qualify due to the income or poverty criterion.)

The authors use the median income ratio of 0.8 to separate census tracts into a qualifying and non-qualifying group, and then compare tracts that are close to and on either side of the 0.8 cutoff. The economic outcomes they examine are employment at new firms, number of new firms, and new employment at existing firms.

They find that there was less new employment at new firms in NMTC eligible tracts in the transportation and wholesale industries but more new employment in the retail industry. Figure 2 shows that retail received a relatively large portion of the tax credits. This result shows that the tax credits helped new retail firms add workers relative to firms in transportation and manufacturing in eligible census tracts.

The authors note that the magnitude of the effects are small—a 0.2% increase in new retail employment and a 0.12% and 0.41% decrease in new transportation and wholesale employment respectively. Thus the program had a limited impact during the 2002 – 2006 period according to this measure, despite the fact that nearly $8 billion was granted to investors from 2002 – 2005.

The authors find a similar result when examining new firms: Retail firms located in the NMTC eligible tracts while services and wholesale firms did not. Together these two results are evidence that the NMTC does not benefit firms in all industries equally since it causes firms in different industries to locate in different tracts. The latter result also supports the idea that firms that benefit most from the tax credit crowd out other types of firms, similar to the earlier hotel and retail store example.

Finally, the authors examined new employment at existing firms. This result is more favorable to the program—an 8.8% increase in new employment at existing manufacturing firms and a 10.4% increase at retail firms. Thus NMTCs appear to have been primarily used to expand existing operations.

But while there is evidence that the tax credit slightly increased employment, the authors note that due to the limitations of their data they are unable to conclude whether the gains in new employment or firms was due to a re-allocation of economic activity from non-eligible to eligible census tracts or to actual new economic activity that only occurred because of the program. Thus even the small effects identified by the authors cannot be conclusively considered net new economic activity generated by the NMTC program. Instead, the NMTC program may have just moved economic activity from one community to another.

The mixed results of this recent study combined with the inability to conclusively assign them to the NMTC program cast doubt on the programs overall effectiveness. Additionally, the size of the effects are quite small. Thus even if the effects are positive once crowding out and reallocation are taken into account, the benefits still may fall short of the $43.5 billion cost of the program (which doesn’t include the program’s administrative costs).

An alternative to location-based tax credit programs is to lower tax rates on businesses and investment across the board. This would remove the distortions that are inherent in location-based programs that favor some areas and businesses over others. It would also reduce the uncertainty that surrounds the renewal and management of the programs. Attempts to help specific places are often unsuccessful and give residents of such places false hope that community revitalization is right around the corner.

Tax credits, despite their good intentions, often fail to deliver the promised benefits. The alternative—low, stable tax rates that apply to all firms—helps create a business climate that is conducive to long-term planning and investment, which leads to better economic outcomes.

You’ve heard it before. Americans are deeply unhappy with Washington, DC. Sixty-five percent say the country is on the wrong track. Confidence in institutions is near all-time lows. Congress’s approval rating is terrible, and the two major presidential candidates are viewed more negatively than any other mainstream presidential candidates in recent memory. Only nineteen percent of the public trust the government to do the right thing all or most of the time.

Washington’s dysfunction—what is probably driving these perceptions—extends to all three branches of the federal government. Congress is in a near-permanent state of gridlock. The president uses his executive authority wherever possible, but often with little practical impact. Even regulatory agencies are facing what Brookings Institution scholar Philip Wallach has dubbed a legitimacy crisis of the administrative state, as the public grows more skeptical of leaving the most important policymaking decisions to insulated and unelected regulators.

The courts are in little better shape. Since the death of Justice Antonin Scalia, the Supreme Court has been hobbled without its ninth member. Even before this development, there was a perception building that politics too often enters the Court’s decisions, no doubt contributing to the gradual increase in the Supreme Court’s disapproval rating over time.

On a brighter note, in contrast to this crisis of legitimacy at the federal level, polling data suggests that Americans still generally trust their state and local governments. The cop on the beat, the garbage man, and the postal worker, are still trusted symbols of everyday American life.  Furthermore, the social divisions that make dramatic change at the federal level difficult (i.e. red state versus blue state stuff) actually make it easier to get things done in the states.

Where governorships and state legislatures are dominated by a single party, there are opportunities to advance creative policy solutions, allowing the states to fulfill their roles as laboratories of democracy. Policy reforms in the states, where successful, can lay the groundwork for future changes at the federal level, perhaps restoring badly-needed trust in our ailing institutions.

There are a many reasons to be cynical about where the country is headed, and to doubt whether our leaders are capable of addressing our looming challenges. However, the states should not be made complacent by this state of affairs. They should view Washington’s dysfunction as an opportunity and not a reason for despair. Now is an opportune moment to step up and demonstrate what it means to govern. Perhaps…just perhaps… our friends in Washington might pay attention and learn something.

Tax increment financing, or TIF, is a method of financing economic development projects first used in California in 1952. Since then, 48 other states have enacted TIF legislation with Arizona being the lone holdout. It was originally conceived as a method for combating urban blight, but over time it has become the go-to tool for local politicians pushing economic development in general. For example, Baltimore is considering using TIF to raise $535 million to help Under Armor founder Kevin Plank develop Port Covington.

So how does TIF work? Though the particulars can vary by state, the basic mechanism is usually similar. First, an area is designated as a TIF district. TIF districts are mostly industrial or commercial areas rather than residential areas since the goal is to encourage economic development.

Usually, in an effort to ensure that TIF is used appropriately, the municipal government that designates the area as a TIF has to assert that economic development would not take place absent the TIF designation and subsequent investment. This is known as the ‘but-for’ test, since the argument is that development would not occur but for the TIF. Though the ‘but-for’ test is still applied, some argue that it is largely pro forma.

Once an area has been designated as a TIF district, the property values in the area are assessed in order to create a baseline value. The current property tax rate is applied to the baseline assessed value to determine the amount of revenue that is used for the provision of local government goods and services (roads, police, fire, water etc.). This value will then be frozen for a set period of time (e.g. up to 30 years in North Carolina), and any increase in assessed property values that occurs after this time and the subsequent revenue generated will be used to pay for the economic development project(s) in the TIF district.

The key idea is that municipalities can borrow against the projected property value increases in order to pay for current economic development projects. A simple numerical example will help clarify how TIF works.

In the table below there are five years. In year 1 the assessed value of the property in the TIF district is $20 million and it is determined that it takes $1 million per year to provide the government goods and services needed in the area (road maintenance, sewage lines, police/fire protection, etc.). A tax rate of 5% is applied to the $20 million of assessed value to raise the necessary $1 million (Tax revenue column).

TIF example table

The municipality issues bonds totaling $1 million to invest in an economic development project in the TIF district. As an example, let’s say the project is renovating an old business park in order to make it more attractive to 21st century startups. The plan is that improving the business park will make the area more desirable and increase the property values in the TIF district. As the assessed value increases the extra tax revenue raised by applying the 5% rate to the incremental value of the property will be used to pay off the bonds (incremental revenue column).

Meanwhile, the $1 million required for providing the government goods and services will remain intact, since only the incremental increase in assessed value is used to pay for the business park improvements. Hence the term Tax Increment Financing.

As shown in the table, if the assessed value of the property increases by $2 million per year for 4 years the municipality will recoup the $1 million required to amortize the bond (I’m omitting interest to keep it simple). Each $1 million dollars of increased value increase tax revenue by $50,000 without increasing the tax rate, which is what allows the municipality to pay for the economic development without raising property tax rates. For many city officials this is an attractive feature since property owners usually don’t like tax rate increases.

City officials may also prefer TIF to the issuance of general obligation bonds since the latter often require voter approval while TIF does not. This is the case in North Carolina. TIF supporters claim that this gives city officials more flexibility in dealing with the particular needs of development projects. However, it also allows influential individuals to push TIF through for projects that a majority of voters may not support.

While TIF can be used for traditional government goods like roads, sewer systems, water systems, and public transportation, it can also be used for private goods like business parks and sports facilities. The former arguably provide direct benefits to all firms in the TIF district since better roads, streetscapes and water systems can be used by any firm in the area. The latter projects, though they may provide indirect benefits to nearby firms in the form of more attractive surroundings and increased property values, mostly benefit the owners of entity receiving the development funding. Like other development incentives, TIF can be used to subsidize private businesses with taxpayer dollars.

Projects that use TIF are often described as ‘self-financing’ since the project itself is supposedly what creates the higher property values that pay for it. Additionally, TIF is often sold to voters as a way to create jobs or spur additional private investment in blighted areas. But there is no guarantee that the development project will lead to increased private sector investment, more jobs or higher property values. Researchers at the UNC School of Government explain the risks of TIF in a 2008 Economic Bulletin:

“Tax increment financing is not a silver bullet solution to development problems. There is no guarantee that the initial public investment will spur sufficient private investment, over time, that creates enough increment to pay back the bonds. Moreover, even if the investment succeeds on paper, it may do so by “capturing” growth that would have occurred even without the investment. Successful TIF districts can place an additional strain on existing public resources like schools and parks, whose funding is frozen at base valuation levels while growth in the district increases demand for their services.”

The researchers also note that it’s often larger corporations that municipalities are trying to attract with TIF dollars, and any subsidies via TIF that the municipality provides to the larger firm gives it an advantage over its already-established, local competitors. This is even more unfair when the local competitor is a small, mom-and-pop business that already faces a difficult challenge due to economies of scale.

There is also little evidence that TIF regularly provides the job or private sector investment that its supporters promise. Chicago is one of the largest users of TIF for economic development and its program has been one of the most widely studied. Research on Chicago’s TIF program found that “Overall, TIF failed to produce the promise of jobs, business development or real estate activity at the neighborhood level beyond what would have occurred without TIF.”

If economic development projects that rely on TIF do not generate additional development above and beyond what would have occurred anyway, then the additional tax revenue due to the higher assessed values is used to pay for an economic development project that didn’t really add anything. Without TIF, that revenue could have been used for providing other government goods and services such as infrastructure or better police and fire protection. Once TIF is used, the additional revenue must be used to pay for the economic development project: it cannot be spent on other services that residents might prefer.

Another study, also looking at the Chicago metro area, found that cities that adopt TIF experience slower property value growth than those that do not. The authors suggest that this is due to a reallocation of resources to TIF districts from other areas of the city. The result is that the TIF districts grow at the expense of the municipality as a whole. This is an example of the TIF working on paper, but only because it is pilfering growth that would have occurred in other areas of the city.

Local politicians often like tax increment financing because it is relatively flexible and enables them to be entrepreneurial in some sense: local officials as venture capitalists. It’s also an easier sell than a tax rate increase or general obligation bonds that require a voter referendum.

But politicians tend to make bad venture capitalists for several reasons. First, it’s usually not their area of expertise and it’s hard: even the professionals occasionally lose money. Second, as Milton Friedman pointed out, people tend to be more careless when spending other people’s money. Local officials aren’t investing their own money in these projects, and when people invest or spend other people’s money they tend to emphasize the positive outcomes and downplay the negative ones since they aren’t directly affected. Third, pecuniary factors don’t always drive the decision. Different politicians like different industries and businesses – green energy, biotech, advanced manufacturing, etc. – for various reasons and their subjective, non-pecuniary preferences may cause them to ignore the underlying financials of a project and support a bad investment.

If TIF is going to be used it should be used on things like public infrastructure – roads, sewer/water lines, sidewalks – rather than specific private businesses. This makes it harder to get distracted by non-pecuniary factors and does a better – though not perfect – job of directly helping development in general rather than a specific company or private developer. But taxpayers should be aware of the dangers of TIF and politicians and developers should not tout it as a panacea for jump-starting an area’s economy.

In the latest example of politics trumping economics, Washington DC’s city council voted to increase the city’s minimum wage to $15 per hour by 2020. The economic arguments against a minimum wage are well-known to most people so I won’t rehash them here, but if you want to read more about why the minimum wage is bad policy you can do so here, here, and here.

In a nutshell, the minimum wage prices lower-skill workers out of the market by setting the wage higher than the value they can produce for their employer; if a worker only produces $9 worth of value in an hour an employer can’t pay her $10 per hour and stay in business.

The minimum wage has the strongest impact on low-skill workers since they tend to produce the least amount of value for their employers. Two categories of such workers are teenagers, who lack experience and have yet to finish their education, and adults with less than a high school degree. The figures below depict the employment and unemployment rates for these two groups in the Washington DC metro area (MSA) and the city proper (District only) from 2009 to 2014 (most recent data available) using 5-year American Community Survey data from American FactFinder.

DC 16-19 employed

As shown in the figure only about 15% of DC’s 16 – 19 year olds were employed (orange) in 2014 compared to about 25% in the MSA as a whole. The percentage has fallen since 2009 and doesn’t appear to be recovering. Increasing the price of such workers certainly won’t help.

The next figure shows the percentage of people with less than a high school degree who were employed.

DC less HS employed

Again, the percentage has fallen in DC since 2009 and is far below the MSA as a whole. Less than half of adults with less than a high school degree are employed in DC compared to 67% in the Washington metro area. If employers relocate to other jurisdictions within the MSA once the minimum wage law takes effect it will make it more difficult for the less-educated adults of DC to find a job.

The next two figures show the unemployment rates for both groups in both areas. As shown, the unemployment rate is higher in DC than in the MSA for both groups and has been trending upward since 2009.

DC 16-19 unemp

DC less HS unemp

It’s outlandish to think that raising the minimum wage will improve things for the 35% of 16 – 19 year olds and 21% of high school dropouts who were looking for a job and couldn’t find one under the old minimum wage of only $9.50.

Politicians and voters are free to ignore economic reality and base their decision making on good intentions, but when doing so they should at least know the employment facts and be made aware of the futility of their intentions. I predict that we will see more automation in DC’s restaurants, hotels, and bars in the future as workers get relatively more expensive due to the higher minimum wage. This will only make it harder for DC’s teenagers and less-educated residents to find work, which as shown above is already a difficult task.

Northern Cities Need To Be Bold If They Want To Grow

May 11, 2016

Geography and climate have played a significant role in U.S. population growth since 1970 (see here, here, here, and here). The figure below shows the correlation between county-level natural amenities and county population growth from 1970 – 2013 controlling for other factors including the population of the county in 1970, the average wage of the […]

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Baltimore’s misguided move to raise its minimum wage will harm its most vulnerable

April 22, 2016

Baltimore’s city council, like others around the country, is considering raising the city’s minimum wage to $15 per hour. This is an ill-advised move that will make it harder for young people and the least skilled to find employment, which is already a difficult task in Baltimore. The figure below shows the age 16 – […]

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States with lower minimum wages will feel the impact of California’s experiment

April 8, 2016

California governor Jerry Brown recently signed a law raising California’s minimum wage to $15/hour by 2022. This ill-advised increase in the minimum wage will banish the least productive workers of California – teens, the less educated, the elderly – from the labor market. It will be especially destructive in the poorer areas of California that […]

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A $15 minimum wage will excessively harm California’s poorest counties

March 30, 2016

Lawmakers in California are thinking about increasing the state minimum wage to $15 per hour by 2022. If it occurs it will be the latest in a series of increases in the minimum wage across the country, both at the city and state level. Increases in the minimum wage make it difficult for low-skill workers to find […]

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Exit, voice, and loyalty in cities

March 18, 2016

Economist Albert Hirschman’s 1970 book Exit, Voice, and Loyalty: Responses to Decline in Firms, Organizations, and States presents a theory of how consumers express their dissatisfaction to firms and other organizations after a decline in product or service quality. In terms of interjurisdictional competition exit is demonstrated by migration: dissatisfied residents migrate to a community […]

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Where’s the growth?

March 1, 2016

In a famous Wendy’s commercial from 1984, three elderly women are examining a hamburger with a rather large bun when one of them asks “Where’s the beef?” in order to express her disappointment that the burger is all bun and no meat. When it comes to the economy growth is like the beef of a […]

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