Few tools in the economic developer’s toolbox are used more often to lure prospects to promising locations than subsidies and tax incentives, especially when a big prize is in view.

As a result, large corporations, especially multinationals, have become adept at squeezing the maximum concessions from each bidder – giving rise to a long-standing debate in economic and policy circles about whether the benefits outweigh the costs for the host location.

The coronavirus pandemic has added a new twist to the debate. Many state and local governments are now having to choose whether to insist companies fulfil the conditions of their agreed contracts, or to grant them leeway in view of the global economic disaster caused by Covid-19.

Major spend

The stakes are huge. According to Good Jobs First, a Washington DC-based non-partisan organisation that promotes accountability in economic development, US states and localities spend an estimated $70bn a year on corporate subsidies in the fierce competition to entice companies to locate in their jurisdiction.

That figure includes tax exemptions, job creation tax credits, and property tax abatements. Tax abatement cost states $10bn and local jurisdictions an additional $5bn in 2019, Good Jobs First calculated. The true costs may be much higher, since many investment promotion agencies shroud their offers to companies in secrecy, and compliance with required tax accounting practices is often lax.

Companies may also benefit from government-authorised bonds to build facilities, acquire or develop land, or the use of public funds to construct infrastructure needed for the project. 

Various subsidies

There is enormous variation in the value of incentives offered, according to Timothy Bartik, senior economist and authority on incentives at the W.E. Upjohn Institute for Employment Research in Kalamazoo, Michigan. Mr Bartik calculates the average incentive offer in the US is $30,000 per job, but he notes many offer more than $100,000 per job, and in the case of the Taiwanese company Foxconn’s Wisconsin plant ranged from $172,000 to $290,000 per job under various scenarios. “It is definitely the case that large companies get much higher subsidies,” he says.

Increasingly, in exchange for the granting of subsidies or incentives, companies commit to hire a certain number of people, create a certain number of high-wage jobs, or make specific investments in the locality. However, in the Covid-19 environment, many are struggling with stay-at-home consumers, markets that have collapsed, disrupted supply chains, or export barriers and controls that prevent them from reaching the targets they agreed to.

“There are deals that have been faltering or where companies have asked for extended timelines or revised schedules,” said Greg LeRoy, executive director of Good Jobs First. In a growing number of cases, the granting agency has the option of demanding a refund, or clawback, of the grant if the terms of the contract are not fulfilled. How often this occurs is unclear. Nevertheless, an increasing number of states have adopted legislation to permit clawbacks, following a series of well-publicised debacles.

“It’s less risky and expensive for taxpayers,” says Mr LeRoy. “When done, states rarely announce the clawback. There’s this dogma: if you as a state are seen as being aggressive, you will be seen as less competitive in recruiting deals in the future.” 

Refund or restructure?

Frequently, he notes, the agency may not try to compel a refund. Instead, it may try to recapture some of the subsidy already awarded, recalibrate the amount due going forward, or rescind future subsidies not yet awarded.  

One defence against clawbacks and other penalties that some companies are testing during the pandemic is the concept of force majeure. It is intended to protect the parties if a contract cannot be performed due to causes beyond their control and which they cannot avoid by the exercise of due care. 

However, the defence is only available if it is specifically included in the contract between the parties, says David Marmins, a partner at Atlanta law firm Arnall Golden Gregory. The first question is how the contract defines force majeure. “By almost any definition, force majeure will apply to what we have now, with few exceptions,” he adds. “Almost always, a shutdown will meet the criteria for force majeure.”

A second question is: what is the relief? For example, if a retail mall closes and a store cannot operate, that would meet most definitions of force majeure. But the shopkeeper may still be contractually bound to pay rent at some point. “They are not entitled to a windfall,” says Mr Marmins.

“There will be more litigation the longer this goes on and the more oppressive it is for various industries, and the rebound will take longer,” he predicts. 

Mr LeRoy agrees that force majeure may be a valid argument in some cases. However, he says that if states and localities are going to grant forbearance they have to give it equally.  “If a deal has to be restructured, it should be in agreement with a uniform policy in a performance-based way to reduce government risk,” he said.

Debating the cost

Meanwhile, the debate continues over whether subsidies, incentives and tax abatements are worth their cost to the public. For Mr Bartik, the argument that “but for” the incentive package the target company would not have located, expanded, or retained jobs at a particular location rings hollow. His research shows at least 75% of the time, the same local job creation would have occurred without the incentive. 

He contends that proponents often hide from the public the true cost of infrastructure, housing and other factors that governments assume, as well as the projects that are delayed or cancelled because public funds are diverted to the new project, while indirect job creation – the multiplier effect – is often exaggerated.

Nathan Jensen, a government professor at the University of Texas, Austin, agrees. Monitoring by states of whether companies are meeting the conditions for the incentives is so bad, he says, “a lot of times states may not even care”. He cites the example of Texas, where much of the US  reserve of oil and gas is located, which nevertheless gives incentives to oil and gas companies to operate there.

In the case of subsidies, it seems, hope will always trump experience.

This article first appeared in the August - September edition of fDi Magazine.