Tax Credits to the Rescue!
Vermont's "Economic Advancement Tax Incentive" program continues to make news. On September 20 a Wall Street Journal investigation by Jeff Krasner examined the way in which the Vermont Economic Progress Council (VEPC) has interpreted its "but-for" criterion.
VEPC is a nine-member board of Gov. Howard Dean's appointees who decide whether to approve a wide range of valuable tax credits to firms promising to locate or expand in Vermont. The applying firms must jump through a number of hoops to qualify. One is a cost-benefit analysis. After meetings with legislative committees concerned about subsidizing activity that would have happened anyway, VEPC decided to include as a key component of that test whether the promised investment and job creation would not have been undertaken "but for" the tax credits.
Last June Auditor Edward Flanagan released a scathing report claiming that VEPC was mismanaging the program, and in particular approving credits for firms that didn't meet the "but for" test. Flanagan's report cited examples of firms that he believed shouldn't have qualified for credits, but did not release the names of those firms.
Reporter Krasner sniffed out and contacted 13 of the firms involved. Only two of the firms contacted said the credits were the deciding factor. One said the firm would have expanded anyway. Krasner found that compliance with the "but-for" test was "murky at best" for the other ten firms. His conclusion: "Vermont has granted millions of dollars of tax credits to companies that say they would have made investments in the state regardless of whether they received government assistance."
Particularly instructive - though not mentioned by name in Krasner's story - is the way the tax credits were used to subsidize Husky Injection Molding in Milton. Husky was and is a wonderful company to have in Vermont. Once Gov. Dean saw a possibility of luring Husky away from locating in New York or Indiana, he mounted a crash program to sell the firm on Vermont.
In June 1996 Husky, the state and the town of Milton entered into a Memorandum of Understanding. A key provision was that the state and local governments would make their best efforts to deliver a $6 million dollar bridge to the site. But in November 1997 the state embarrassingly conceded that Vermont's congressional delegation had failed to extract the bridge dollars from Washington, the state didn't have the money, and Husky would have to build its own bridge At the time of this admission Husky already had the steelwork up for its new Milton plant.
At the same time Husky was expressing concern about the status of its property tax stabilization agreement with Milton, with the state taking control of such town agreements as part of the newly enacted Act 60. So in January of 1998 Gov. Dean proposed and the legislature enacted the VEPC program. By December VEPC was ready to do business. On December 3, Husky filed its application for three kinds of tax credits. Within four weeks VEPC had approved a $10.6 million award, the largest ever made.
But wait! What about the "but for" test? Husky's plant had been under construction for over a year by the time VEPC approved Husky's tax credits. Was it reasonable to believe that without the tax credits, Husky would have abandoned Milton and moved to New York or Indiana? Not likely. (VEPC says the credits were for future expansions, but they were part of Husky's long range plan.)
The truth of the matter is this: Husky was given to believe in 1996 that the state would pay for the $6 million dollar bridge. A year later the State told Husky that, sorry, but Husky would have to pay for its own bridge.
The Governor then pushed through his VEPC program, and Husky was invited to come in for the credits. Instead of getting the one-time gift of a $6 million bridge from the taxpayers, Husky got $10.6 million in tax credits. To make this happen, the VEPC board simply threw any meaningful version of its "but for" test in the trash can.
Vermont has Husky, and Husky will save more than enough in tax credits to pay for its bridge. One might consider that a happy outcome. But it's hard to avoid another conclusion: the VEPC tax credit program offered a highly convenient - and costly - way for the State to bail itself out of an embarrassing failure to deliver on, if not a hard promise, at least a good faith pledge made to a favored corporation.. Whether VEPC approved Husky's credits at the bidding of the governor who made but couldn't keep the state's part of the 1996 "understanding" has never been publicly disclosed. VEPC's critics claim that no matter how well-meaning a governor's appointees on the VEPC board may be, the program will sooner or later become "crony capitalism" and used for political advantage. After the Husky experience, they certainly deserve a more respectful hearing.
Crony Capitalism Starting To Get Bad Reviews
The "Economic Advancement Tax Incentive" (EATI) program enacted by the legislature in 1998 now has a year under its belt, and already the legislature has taken steps to rein it in.
The EATI program, Vermont's version of "crony capitalism", was rushed into existence last year as the Dean Administration's way of allowing certain politically favored corporations to escape the economic penalties of Act 60's statewide property tax. The act created a Vermont Economic Progress Council composed of nine appointees of the Governor. This elite body is authorized to grant worthy applicants an amazing range of benefits: payroll tax credits, R & D tax credits, workforce development credits, export incentive credits, small business credits, training assistance and property tax stabilization.
To get these goodies an applying firm must show that it will locate where the state says, hire Vermont residents, pay high wages, offer extensive benefits, use Vermont resources, comply with state plans, and "strengthen the quality of life". Since the Governor does not want any assisted firm to fail and give the program a bad name, he can send pointed messages to the regulatory bureaucracy (at least those that he nominally controls) to see that applications move. Husky Injection Molding in Milton is the classic example of a project advanced at breathtaking speed by intense gubernatorial interest.
From all accounts the current VEPC Board is trying to be very conscientious about its work. Nonetheless, the program brings to mind the classic political question: what is the difference between Reform and the Machine? About three years.
Earlier this year the Joint Fiscal Office hired analyst Tom Kavet to review the workings of the EATI. Here are some of his findings:
* Much of what VEPC subsidized would have happened anyway. The tax subsidies may have made some projects larger (by the amount of the credits), but in some cases the subsidies were simply a cash payment to the favored corporation.
* More than 70 percent of the awards have been made to Chittenden County, with the lowest unemployment rate in the state. Total subsidies approved for the five counties with the highest unemployment rates (Caledonia, Orleans, Essex, Franklin, Grand Isle): zero.
* Well over half of the new jobs created will be filled by new in-migrants to Vermont. * Direct subsidies like EATI "are generally considered to be the most expensive way for a state to achieve [economic] benefits."
* There is no upper limit to the potential cost to the state of this program. Kavet might also have noted that contrary to the statute, the VEPC board members do not represent the "various geographical areas of the state." Four are from commuting distance of downtown Burlington, and only one, from Brattleboro, is from the east side of the mountains.
The report the Council was required to give to the legislature in January contained almost none of the information the legislature told it to present. Rep. Terry Bouricius (P-Burlington) observed that "apparently the Council was so busy giving away tax breaks that they didn't take the time to analyze alternative economic development strategies other than tax credits." Bouricius also noted the complaint of one small business person that VEPC handed out valuable tax credits to its competitor.Thanks largely to his efforts, the 1999 legislature put a dollar cap on VEPC's handouts, and mandated more detailed reporting starting in January 2000.
But annually attempting to rein in a runaway crony capitalism program is not the real solution. The real solution was contained in a policy statement adopted in 1993 by the National Governors Association: "The Governors believe that the public and private sectors should undertake cooperative efforts that result in improvements to the general economic climate rather than focus on subsidies for individual projects and companies."
That statement was adopted with the support of NGA Vice Chairman Gov. Howard Dean (D-VT). Apparently he wasn't very serious about it.
The Filene’s Bills: Greasing the Skids for Burlington
Two years have gone by since the legislature, urged on by Gov. Dean, began to slip various thinly disguised subsidies into legislation to support the location of a big new Filene's Department Store in downtown Burlington. Now is a good time to take a look at the results.
The Filene's fun began when Sen. Cheryl Rivers and Sen. Helen Riehle secured adoption of the "Filene's Amendment" to Act 60 in 1997. Their amendment exempted from the sales tax "sales of building materials within any three consecutive calendar years, in excess of one million dollars in purchase value, incorporated into a downtown redevelopment project." In other words, only a big corporation ready to spend a million bucks in building materials got the tax exemption, and only if it built where the local politicians said, like on Church Street in Burlington.
But apparently that wasn't enough to secure Burlington's happiness. The following year the legislature passed Act 120, popularly known in Montpelier as "the Filene's Bill". This act created a new state board composed of eight state employees and one city official. This Downtown Development Board approves applications from towns to get in on the downtowns gravy. The approved towns or cities receive various planning and assistance grants. They go to the head of the line for coveted community development block grants. Owners of buildings in approved downtown districts qualify for extensive tax credits for building rehabilitation, and for training and hiring workers who were previously on welfare.
To qualify for the Board's designation, the law says that a town or city must show among other things that it is in compliance with all state sewage disposal requirements, and that it "has dedicated a portion of any unallocated reserve capacity of the sewage and public water supply for growth within the proposed downtown district."
On January 6 Burlington sent its first team, headed by Mayor Peter Clavelle and City Treasurer Brendan Keleher, to the initial meeting of the Downtown Development Board. Their goal was to secure a quick designation, and to get a commitment for as much as possible of the new Downtown Development Fund.
But a potential difficulty appeared in Burlington's application: Burlington had declined to dedicate unallocated water and sewer reserve capacity to accommodate growth. No matter! Burlington's application whizzed through the Board like salts through a heifer. As for Burlington's request for a commitment of turn over to Burlington 62% of the expected revenues to the fund for the next ten years, no problem. Done. Apparently slightly abashed for having looted the Fund for the next decade, Mayor Clavelle helpfully suggested that the "legislature should be convinced to appropriate more" to replenish the fund for other less influential towns.
Rutland's turn came at the February 22 Board meeting. Rutland, with the state's most celebrated downtown renewal project, was not willing to tie up its sewer and water capacity any more than Burlington was. Its spokesmen made the point that if Burlington was eligible for designation without reserving capacity, why not Rutland.? No, said the Board, Rutland (with no Filene's planned) doesn't qualify. Counsel solemnly reminded the Board that "no reserve, no designation". At this point the minutes show that "the Chair reminded the Board that it cannot go against the statute", a thought that would have been highly pertinent when her Board ignored the law and gave away the store to Burlington a month earlier.
Then there was St. Johnsbury. The details are a bit complicated, but St. Johnsbury received conditional designation only when the Agency of Natural Resources, obviously under some pressure to stop finding reasons why the act was unworkable for any town without a Filene's in it, agreed to enter into a new regulatory deal postponing the town's sewage system compliance for four more years.
So here's the bottom line on the "downtowns bill" so far. Burlington, a city that got away with dumping its sewage plant effluent into the Class B Lake Champlain waters for 17 years without a penalty, again got what it wanted without meeting the requirements of the law. Rutland refused to meet the requirement that Burlington avoided, and was sent away empty handed. A state agency had to finesse St. Johnsbury's non-compliance so the Board could avoid the embarrassment of rejecting yet another non-Filene's application. Towns which refuse to be drawn into this regulatory whirlpool for the modest benefits remaining will have to go to the rear of the line in competing for the state CDBG grants. The reform of what is perhaps the major problem facing downtown redevelopment - state regulations like the Labor and Industry building code - continues unaddressed.
The "Filene's amendment" and "the Filene's bill" have clearly succeeded in letting other Vermonters subsidize Burlington and Filene's. And that's good for Burlington and Filene's. As for the rest of the state's towns, held to a more stringent standard, the Downtowns bill has become "a big hassle with a small payoff", to paraphrase one town official.
That's the kind of thing that is highly likely to happen when the governor and legislature rush through poorly thought out legislation designed to mask from public view its main purpose: subsidizing one politically powerful city government and one large favored corporation.
Crony Capitalism Comes to Vermont
Textbook capitalism is an economic system where the government establishes some basic rules, such as rights to property, enforcement of contracts, liability for damages, an independent judiciary to settle disputes, and a stable and predictable tax system. The government also provides a basic transportation infrastructure, backs a stable currency, and brings lawbreakers to justice.
Given these ground rules and public services, individuals and corporations invest their funds, produce goods and services, and offer them on the market. If consumers respond, they earn a return on their investment. In such a system it doesn't matter who you know. The rules apply fairly and equally to all, and who succeeds and who fails is determined in the marketplace.
Now consider "crony capitalism", the traditional name that describes most non-communist Third World economies (plus, one might argue, Arkansas and Louisiana). In such countries the only way to have your business succeed is to become a crony of the political leadership, through family and social ties, bribes, kickbacks, and political support.
With the passage of the "economic progress act" of 1993, the "economic advancement incentives" of 1998, and the "downtowns bill" of 1998, all coupled with Act 250 (1970), Vermont is on the way to a unique Yankee brand of "crony capitalism". The difference between Vermont and, say, Brazil is that in Vermont, at least for now, state permission, assistance, and subsidies will be given out for high-minded public reasons, not for corrupt individual benefit. But the aspiring entrepreneur who has no interest in cozying up to Vermont's political leadership will have just as much success as his or her counterpart in Mexico or Brazil.
The goal of the people who are bringing crony capitalism to Vermont is to control economic activity "for the people." And here is how it works. First, the barriers to new enterprise must be raised - raised so high that no one can afford the time and money to get over them without government support. Business taxes are a barrier, but not an insurmountable one. The real barrier is the state's byzantine, costly, expert-intensive, arbitrary, and seemingly endless regulatory process. This process features Act 250, wetlands rules, labor and industry rules, workmen's compensation rules, and many others (most recently, new rules about curb cuts onto public highways). This is a state where it takes 25-30 permits to run a little grocery. Not only are there numerous permits and rules to be complied with, but the enforcing bureaucrats often seem to feel little urgency about giving timely and definitive answers to applicants, even when the fate of a small business owner's enterprise is hanging in the balance.
Once the barriers have been raised to daunting levels, the friendly state government offers assistance - provided the applicant does all the politically correct things. That assistance may include payroll tax credits, R&D tax credits, workforce development credits, export incentive credits, small business credits, training assistance and property tax stabilization. Also available are pointed messages from "upstairs" to the regulatory bureaucracy that a project should go forward, or be stopped. Husky is the classic example of a major project that sailed through the process, because the Governor created a high-level task force to see that it did. The proposed gas station at Exit 9 of I-91 is the current example of the opposite; the Governor vowed that it will never be built.
But these benefits to business don't come without a price. The price is that the applicant must locate the business where the state wants it, hire Vermont residents, pay high wages, offer extensive benefits, use Vermont resources, comply with state plans, be receptive to union organizing, and "strengthen the quality of life". Making contributions to organizations which promote these goals couldn't hurt, either. For most of the tax benefits the applicant must prove that he or she satisfies all these requirements to the "Vermont Economic Progress Council", nine appointees of the Governor who serve at his pleasure and are not confirmed by the Senate. This device is only one step removed from Gov. Howard Dean's original 1993 proposal that anyone wishing to enjoy the benefits of the "economic progress" tax credits had to obtain the governor's personal approval.
Is this "crony capitalism"? Well, if you can't overcome the many barriers Vermont's tax and regulatory system impose without obtaining special government benefits and advantages, it's hard to see why it's not. And no matter how high minded it may seem at first, the inevitable result of such a system is not capitalism. It is a corrupted pseudo-capitalism that will drive off the entrepreneurs who despise making political deals to ensure business success. It will encourage those most eager to get rich by making mutually profitable deals with those in power in the government. At least Vermont's version is likely to be much less violent than Guatemala's.
Buying An Economy
In his well-received State of the State address, Gov. Dean offered what he called a "new way of looking at the future of our state". And in some respects - notably electric industry deregulation and public school choice - Dean opened the door to a society more nearly based on the free market principles of competition and consumer choice. But on the economic development side, the Dean prescription for Vermont's future is quite the opposite: increased government control of economic activity.
Responding to a plea from Commerce and Community Development Secretary William Shouldice IV, who is constantly confronted with the problem of high-wage manufacturers slipping away from Vermont (this month's threat: Simon Pearce), the Governor asked for more tools for the "economic development tool kit".
First, he asked that the "Economic Progress Payroll Tax Credit", be brought back from the dead. This scheme offered a credit of as much as $300 per year for ten years to companies which hired additional workers . Enacted with much fanfare as a centerpiece of the "Economic Progress Act " of 1993, this credit had never been claimed when the legislature cut off new applications in 1995. But Gov. Dean apparently remains hopeful that somewhere there must be some employer who can be induced to apply for such a credit, presumably when the amount is sharply increased .
Then there is a Research and Development Tax Program, which would offer ten percent of something (not specified) to "talented, small business entrepreneurs who want to establish or expand their businesses in Vermont." This is apparently a revival of the R&D tax credit, enacted in 1992.
Next comes a "Workforce Development Incentive Tax Credit", again ten percent of something unspecified. This is presumably a handout to companies to train their tax-subsidized new employees to operate the machinery whose costs are 100% subsidized under the original Economic Progress Act and the newly-proposed Small Business Investment Tax Credit. This latter proposal would offer 5-10% credits for plant and equipment investments exceeding $250,000.
"Materials used in certain manufacturing plant expansion and renovation projects" would be exempted from the sales tax, just in time to save Husky Injection Molding the money it needs to pay for the bridge over Arrowhead Lake that Husky was led to believe would be built at taxpayer expense. And there will be a sales tax exemption for "major telecommunications equipment purchases", which may soften the blow of Act 60's 4.36% telecommunications tax.
What this array of new tax credits and incentives means is that the Dean Administration is still trying to buy Vermont an economy for the future. The Governor has always viewed economic development as an intensely political matter, offering numerous opportunities for high-stakes, personal deal-making by the Governor. This kind of guided economic development has the enormous benefit not only of showing the Governor at plant ribbon cuttings, but also putting the Governor into face to face discussions with Powerful Businesspeople Who Can Raise Money, and allowing him or her to control the location of growth in ways agreeable to the politically powerful environmental lobbies. In fact, the original 1993 version of Gov. Dean's Economic Progress Act required that all of the tax credits be approved by the Governor himself, so the beneficiaries would have no doubt who to thank.
Contrast this policy with its opposite, a thoroughly non-political economic development policy. Such a policy would offer low and stable tax rates; a minimum of costly employment mandates; swift, fair, reasonable, and certain health, safety and environmental regulation; good public airports and highways; a state of the art telecommunications system; a tough-on-crime law enforcement and corrections regime; and an educational system producing highly skilled and dependable employees.
To implement that kind of economic development policy requires a political leader to undertake a lot of hard work, public education, and the expenditure of political capital. In return, he gains few conspicuous opportunities for short run political rewards. Nonetheless, that was the policy of the most notable contemporary economic development leaders: Ludwig Ehrhard in West Germany, Vaclav Klaus in the Czech Republic, Mart Laar in Estonia, Roger Douglas in New Zealand.
It is clearly not the policy either of Howard Dean or of his supposed opposition party. Senate Republican leader Robert Ide told reporters that Gov. Dean's speech was "a good , sound Republican sort of speech", perhaps recalling that every Republican in the Senate, and all but one in the House, voted for this same grab bag of stuff when Gov. Dean asked for it in 1993.
But in the long run - the 20 year vision suggested by the Governor - a politically managed economy, saddled with costly state mandates, dependent for growth upon carefully regulated, tax -subsidized businesses locating and operating where and how a Governor finds it to his political advantage to specify, can not become a vigorous, dynamic, prosperous, economy. It can only become a "crony capitalist" economy, where economic success is achieved by cozying up to the leaders of the government, and begging for their favors.
Sweet Deal for the Big Dog
It was good news for Vermont when the Husky Injection Molding Systems of of Bolton, Ontario announced that it intended to build a $50 million, 200-job plant in Milton. The Dean Administration had mounted an aggressive campaign to bring Husky to Vermont, under the code name "Project Big Dog".
Now that the euphoria over the announcement has subsided, it may be worthwhile to examine just what Vermont had to do to persuade this highly desirable company to locate here.
Let's begin with planning, an idea promoted so enthusiastically by Gov. Kunin, who pushed Act 200 through to passage in 1988. Milton prepared a town plan in accordance with that Act's guidelines. Several years ago the Chittenden County Regional Planning Commission approved Milton's plan as being in compliance with Act 200. The Regional Planning Commission also adopted its Regional Plan in accordance with Act 200.
Now here, certainly, is an occasion to celebrate wise planning, so strongly encouraged by Act 200. With careful attention to Act 200's goals and guidelines, consideration of all relevant factors, and lots of public participation, the people of Milton and Chittenden County made important and informed decisions about their future growth and development. Huzzah for the planning process!
Unfortunately the town and regional plans did not anticipate that this outstanding firm would want to locate on the shores of Arrowhead Lake in Milton. The town plan called for low density rural residential use on Husky's chosen site. The town zoning bylaws, based on the town plan, required a 9.1 acre lot per residence. They also allowed three single residential units to be placed on 10 acres if part of a Planned Residential Development. Milton's zoning did not permit $50 million factories on the shores of Arrowhead Lake.
The town is now busily revising its town plan and zoning bylaws to correct the oversight that would have prohibited the Husky plant.
The Chittenden County Regional Plan was in the process of its 5 year amendment when the Husky possibility materialized. The Plan was promptly revised to designate the Husky site as part of an "urban mixed use" district which allows a Husky-style industrial park.
So much for the wonders of planning.
One of the reasons why the planners failed to anticipate industrial development on this site was the difficulty of access. To get materials in and out of the site, Husky will eventually need a bridge across Arrowhead Lake. The town planners of course designated areas with existing transportation access as prime industrial sites.
But Husky wasn't interested in those sites, so the town and state have now obligated themselves to build a $7 million bridge by June 2001. If the state can't write this commitment in stone, with all required permits, by March 29, 1997, Husky says all of its commitments are off. Senators Leahy and Jeffords have been asked to get Uncle Sam to come up with the $7 million ASAP.
Husky will need lots of electricity. The state - presumably the Governor - obligated itself to put the pressure on CVPS to find some cheap electricity for Husky. Since the Governor controls the Public Service Department which contests CVPS over rates and profits before the Public Service Board, CVPS may feel obliged to accede to the Governor's wishes. After all, the subsidy can be made up by overcharging everybody else.
Husky doesn't like to be soaked for property taxes. So the town agreed (subject to voter approval) to freeze Husky's land value and tax rate for ten years, and tax improvements only at today's tax rate. Very nice.
The town agreed to run water and sewer to the site, which will cost $750,000. Accordingly the town applied to the state for a CDBG grant of $750,000 for this purpose. CDBG grants - totaling $8.7 million for this year - are highly competitive. Since the Governor appointed the nine member Board which recommends the winners, and the Governor's Secretary of Development and Community Affairs acts on the recommendations, Milton looks like a winner in this competition.
What of the incentives offered by Gov. Dean's much heralded "economic progress act"? That 1993 act, heralded as the cornerstone of the Dean Administration's efforts to create new jobs, offered tax credits for capital investment and tax credits for hiring workers. The deal was closed to additional applicants in 1995, but could be reopened as part of a bill to exempt Husky from certain sales tax items, also contemplated in the Big Dog package. But nowhere in the detailed memorandum of understanding between Husky, the State, and Milton is there any mention whatever of the income tax incentives of the "economic progress act".
What are we to conclude from Project Big Dog so far?
First, all the fluff about Act 200 making Vermonters plan wisely for their future is just that - fluff. When a desirable company wants to locate somewhere in Vermont, all the plans and zoning bylaws will be tossed out the window, and new ones written to accommodate the project.
Second, the argument for the economic progress tax incentives looks pretty weak right now. In fact, after three years only four firms had been granted investment tax credits, and one of those has since shut down (Tambrands, in Rutland). No wonder the legislature which so enthusiastically bought into this "industry buying" scheme in 1993 closed the door in l995.
Finally, the state will organize "Project Big Dogs" , complete with state-paid expediter to guide the company through the forest of permit requirements, only for politically valuable firms that might be willing to enter Vermont and have a ribbon cutting photo-op with political leaders. It won't do nearly so much for the small firms in Vermont hoping to expand. In some cases - as in the case of Upper Valley Press of Bradford, now on its way to New Hampshire - the state can't even be bothered.
Instead of crafting all sorts of special incentives and mounting "Project Big Dog" to entice a favored company to come into Vermont, wouldn't it be a lot better if state government made a commitment to low and stable tax rates, swift, fair and certain regulation, a minimum of costly and intrusive business mandates, and active encouragement for our home grown businesses to expand, not move away?