How To Reform The City Industrial Development Board - And Response (4)

  • Thursday, October 2, 2014
  • Richard Ebersole

My aims is to bring to the public’s attention the need for procedural changes that, if implemented, would significantly improve the information available the public, to the City Council and to the City Industrial Development Board about the verifiable benefits and costs of tax incentive financing structures and to make the entire process transparent.

The public, the City Council and the IDB suffer from a lack of independent, verifiable information on the costs and benefits of the various tax incentives approved by those bodies.  The process for receiving tax incentives lacks transparency for the public and for the elected and appointed officials who must approve them.  The system used in Chattanooga is different from how these incentives are treated in the other major metropolitan jurisdictions – Knox County, Knoxville, Metro Nashville, Shelby County and Memphis.

The City of Chattanooga and the IDB should adopt a process that requires all applicants to complete a detailed application form.  The form should be submitted to the IDB and should be a public document.  The IDB should charge a non-refundable fee to the entity seeking the tax incentives based on the amount of the incentive being requested.  The fee proceeds should be used to hire an independent, qualified, financial analysis firm, such as a CPA firm, to develop a detailed analysis of the costs and the benefits to the City and taxpayers of each tax forgiveness request.  A report of those findings and determinations should be made to the City and to the IDB before any action is taken.  The report should be public information.  The IDB should hold at least one publicized meeting for the general public to discuss the report.  The City Council should act upon the report in accordance with the Council’s operating procedures.  This is virtually identical to the process used in the other major Tennessee cities.  No additional cost is incurred by the City.

Background:  I served as a member and officer of the IDB for 23 years, appointed by Mayor Gene Roberts and each successive administration and City Council until the expiration of my term on June 9, 2014.  At the expiration of my last appointment I was Chairman of the IDB.  I have completed approximately $500,000,000 in tax incentive financings throughout the U.S.

primarily in the form of tax exempt bond issues.

Item #1:          This memo is not intended to suggest what the appropriate number of members is for the IDB.  However, changing the number of IDB members, the members themselves or the way in which the members are appointed will not address the fundamental problem of restoring and maintaining the public’s trust in, and understanding of the entire process of providing tax incentives.

            Traditionally, since much of the IDB’s work involves the analysis of complex financing structures, the IDB has consisted primarily of bankers and senior insurance company executives.  The recent Volkswagen expansion alone generated several hundred pages of documents amending the various loan agreements, MOUs with the City, County and State and the lease agreements and PILOT agreements with the IDB.  The complexity and volume of the issues have made many qualified people reluctant to serve on the IDB.  Service on the IDB is voluntary and of course there is no compensation paid to board members.

Item #2:          The public needs to understand that the IDB has no authority to spend taxpayer dollars on any project.  Only the City Council can authorize such expenditures.  The IDB serves as a conduit for the City to funnel such tax incentives as are approved by the City Council to a given enterprise.  Under Tennessee law no individual may receive special tax benefits.  It’s easy to understand why this is the case.  No one wants to pay more in property taxes than his or her next door neighbor simply because that taxpayer got preferential treatment from the taxing authority. 

To allow state and local units of government to provide tax incentives for qualified purposes, such as economic development among others, conduit financing vehicles were permitted where a quasi-governmental entity is the recipient of the tax incentives which it in turn passes along to the designated entity.  As an example, VW pays only a portion of the property tax rate for the City and County (the portion that goes to fund education).  VW is able to receive this benefit because the plant and much of the equipment in the plant is legally owned by the IDB and leased back to VW at a nominal rate.  It is the IDB as the owner of the property that receives the tax forgiveness and then passes those savings on to VW.

                        In the same way, the IDB has no authority, unless directed by the City Council to draw upon or in any way to use the credit of the City of Chattanooga.  No debt issued by the IDB creates any liability whatsoever on the City, unless the City Council has approved that debt as in the case of the recent Black Creek Mountain TIF.   

Item #3:          There are essentially 3 kinds of tax incentives which involve the IDB.

1.      The issuance of industrial development/revenue bonds.  These bonds can be either taxable or tax-exempt.  The IDB makes a determination to issue the bonds based on the economic benefit to the City, primarily increased employment.  No financial liability for the City of Chattanooga is created, nor are any funds from the City involved.  This debt is repaid solely from the revenues of the project being financed with the bond proceeds, or in certain cases by a letter of credit or bond insurance policy provided by the project to the bond holders.  Such “private activity” bonds used to be common but due to changes in federal tax laws very few such bonds have been issued in the past 10 years.

2.      Tax Increment Financing (TIF) is a financing vehicle that has been in use around the state for some years, but until the Black Creek Mountain project had not been used in Chattanooga.  Under this structure, the incremental increase in property taxes created by the project receiving this incentive within a defined geographic area is used to retire the project debt.  Such financing requires the approval of the City Council.  There is currently a moratorium on TIF in Chattanooga while a policy is developed for future TIF projects.

The most common tax incentive in recent years has been the sale-lease back structure.  Under this type of financing, property or equipment is purchased by the IDB with funds provided by the entity seeking the tax incentives.  The IDB as the owner of the property then leases the property back to the company at either a nominal rate, or if money was borrowed to finance the acquisition of the property, the lease rate is set at a level sufficient to retire the debt.  Since the IDB is a quasi-governmental entity, i.e its members are appointed by the City and it exists for a public purpose, it is exempt from property and personalty taxes and can pass these savings on to the entity leasing the property.  This is essentially how the VW project works at least with regard to property tax forgiveness.

 

As a rule, sale-lease back transactions involve a Payment-in-Lieu-of-Tax (PILOT) Agreement.  The PILOT defines the way in which tax incentives will be applied.  Typically there is a period of no tax payments and then over time tax payments escalate until at some point (usually 10 to 20 years) the entity is paying 100% of the tax burden.  The entity is supposed to commit to a certain level of new jobs at certain pay levels, to maintain those levels over an agreed upon period of time and to report on employment levels periodically; all as provided in the PILOT Agreement.  Rarely there will be provision for the forfeiture of the tax benefits if the entity fails to meet the agreed upon criteria – the so-called “claw back” provision.

Item #4:          The problem with PILOT Agreements is that in the present system these are negotiated by the Chamber of Commerce and no part of that process is open to the public.  All the public, the City Council and the IDB sees is the final form of the Agreement.  There is no statement of cost or analysis of benefits.  The Council and the IDB have no way to know what the value of a job is.

First, there is a fundamental conflict created by having the Chamber of Commerce whose mission is the recruitment of business to Chattanooga negotiating PILOT agreements which must balance the interests of the new business with the interests of the taxpayers.  This is not to be critical of the Chamber but they have to be primarily concerned with getting and retaining business and not with the cost and benefits to taxpayers.  It is this conflict that accounts for the absence of transparency in the process.

                        Second, there are no standards or guidelines for approving tax incentives.  For example, the VW expansion starts at 2,000 prospective employees, but when you read the documents they only commit to 80% of that number so really it’s 1,600 jobs and that number must be maintained for only 3 consecutive yars.  But, according to media reports only 61% of those jobs are in Hamilton County, so we’re talking about 976 jobs with perhaps half of those in the City of Chattanooga.  With regard to the property tax component of the VW package which I believe for the City is about $12,000,000 per year the argument is that those 488 workers living in the City will generate more in tax revenues than they cost in lost tax dollars.  But unless you know what a job is worth in additional taxes you can’t know whether or not the benefits justify the cost.  Remember not all jobs are the same.  A line worker may make $50,000 a year and a manager may make $100,000, so their respective levels of contribution to the tax base will be different.  Proponents of the VW incentive package , and I am one, will argue that there are “multiplier” effects for a facility like VW that bring far more benefits to Chattanooga than the direct taxes paid by those employers.  But, without a detailed analysis of cost and benefits no one can accurately value those indirect benefits.

                        This problem exists even when you get to smaller companies with much more modest requests for tax incentives.  Using the recent Coca-Cola Bottling PILOT Agreement, the company had something like 73 current employees and with the tax incentives would hire another 43 for a total of something in the neighborhood of 116 employees.  But the PILOT agreement provided that total employment could drop significantly below the current 73 employees without the company having to repay any of the tax benefits.

  Are Coca-Cola jobs worth more than VW jobs; or, is it the other way around? Without a detailed analysis of some very complex issues no one in the public, on the City Council or on the IDB can answer these kinds of questions and it’s frankly unfair to ask  Council members or the IDB to make these determinations.  Unless we are willing to adopt the necessary changes to provide for an independent, detailed analysis of each application, the public has no reason to have any faith in apparent “backroom” decisions that are made by the City Council or the IDB.

Item #5:          There are better alternatives to evaluating tax incentives including PILOT Agreements than using the Chattanooga model.  Other major jurisdictions use a different approach which makes the process completely transparent to the public and provides the kind of detailed, expert, independent analysis and reporting that Chattanooga is missing.  If you look at how Knoxville, Knox County, Metro Nashville, Shelby County and Memphis approach the question of providing tax incentives you’ll see there is a common thread in their processes which is designed to generate verifiable information from an expert, independent source to guide their IDBs and governments in making decisions on tax incentive requests. 

                        The first step is to have every applicant complete a very detailed application form which includes extensive financial information, details about the business operations, existing and proposed, information on the principal owners/officers of the applicant and so on.  The completed form is then submitted to the IDB and is public information.

                        Along with the application form the applicant is required to pay a non-refundable fee to the IDB.  The amount of the fee is based on the amount of tax incentive being requested.  The proceeds of this fee are then used to pay for the services of a qualified financial analysis firm.  This is typically a CPA firm.  This review is a detailed analysis of the cost to the taxpayers and the benefits that they can expect to receive, including an evaluation of how likely the applicant is to achieve the economic benefits contained in their application.  The reviewing firm then submits a report of its finding to the IDBs and to local governments.  Both the application and the analysis report are public documents.  It may be beneficial to have the Chamber of Commerce and the City’s Departments of Finance and Economic and Community Development comment publically on the report.

                        Such a system relieves the City Council and the IDB from the impossible task of performing a detailed cost-benefit analysis on every proposed project, and it removes even the appearance of any inappropriate influence or backroom deals.  Such a system opens the entire process to public scrutiny and it does so without incurring any cost to the local governments or to the IDB.

Item #6           There are real costs imposed on City taxpayers as a result of granting these tax incentives.  Obviously, there is lost tax revenue from the forgiveness of property taxes, but there are also current expenses of these facilities that have to be paid for and those expenses become an additional burden on the taxpayers.  These costs need to be included in a cost-benefit analysis.

Item #7:          Recent PILOT Agreements, in the case of VW it’s an amendment to the existing PILOT, have contained a new provision providing for the payment of a fee for “economic development” by the recipient.  In the case of Coca-Cola Bottling this was a relatively minor amount, I believe $5,000/year and it was to be paid to the IDB.  But in the case of VW the amount is significant, I believe $425,000/year and as I recall it’s to be paid to the City.  So, there already exists an identifiable source of funding to cover the cost of hiring an outside, expert firm; although I believe that an application fee is still justified.

            Other municipalities, including Memphis and Metro-Nashville use proceeds of the application fee to retain independent counsel for the IDB.  The Chattanooga IDB uses the City Attorney for its counsel.  With the exception of the Black Creek Mountain transaction, this has worked reasonably well for Chattanooga.  However, independent counsel could provide a level of expertise and independence that would avoid the issues of potential conflicts of interest and over-reliance on, or uncertainty about, the legal opinions of special tax counsel; both of which have arisen in the Black Creek Mountain project and the subsequent litigation.   

Item #8:          There is great uncertainty about the PILOT agreements now in existence.  There is no hard, verifiable information about how many PILOTs are in effect or how many recipients of those PILOTs are in compliance with the agreements.  Nor do we know how much tax revenue is being diverted each year.  Non-government sources estimate that currently there are 55 PILOTs which divert something like $2 -$3 million per year in taxes – such estimates must exclude the VW property taxes since that figure is more like $25,000,000/yr for City and County taxes.  A procedure to require, account for, and enforce reporting requirements needs to be defined and adopted.

Richard Ebersole

IDB Member 1992-2014

IDB Chair 2013-2014 

* * *

I want to than Mr. Ebersole for his well written opinion concerning the IDB. His words are good reading and instruction for anyone interested in the do's and do not's concerning a PILOT or TIF.  

If some folks would listen to him and Helen Burns Sharp, another local good government advocate ,concerning how you do certain things in local government, the community would be better served. They both have shown a true concern for their neighbors and community and I applaud them both.  

The folks in Chattanooga, again, need to consider what they have to say, they have nothing to gain other than better government and transparency for the citizens. Thanks. 

Joe Blevins 

* * * 

Wow. Mr. Ebersole's opinion letter is awesome. Chattanooga is fortunate that someone with his experience, expertise, and demeanor has done such a thoughtful analysis.  

The only things he "lacks" is an agenda. How refreshing. I get the impression that he took the time to do this letter because he knows of the problems first hand from his 23 years on the IDB and wants to propose solutions that would benefit us all. 

Helen Burns Sharp 

* * * 

Mr. Ebersole and Helen Sharp we are so very grateful that you both have been willing to share your expertise.  We are hopeful that those who have the power to do so will heed your advice and develop a transparent system for granting PILOT agreements.  A system that included true cost/benefit analysis and follow up performance standards should have already been in place.  

Memphis, Nashville, Knoxville - if they can give these agreements the scrutiny that they require, and the oversight that taxpayers deserve, there's no good reason we can't or shouldn't do the same.   Again, thank you. 

David and Melissa Cantrell
Signal Mountain

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The author  states, "The public, the City Council and the IDB suffer from a lack of independent, verifiable information on the costs and benefits of the various tax incentives approved by those bodies." That begs the question, then why are the incentives being approved by the IDB and elected leaders if cost and benefits cannot be verified?  What the public gets is an economic impact study that uses a multiplier that can be completed by any fifth grade student that didn't fall asleep while learning multiplications.
Here are a couple of stats I pulled this morning from the 2013 Hamilton County Audit:
Debt for total primary government for Hamilton county has grown by $143,440,056. since 2007.
Full time equivalent employees for the county government has grown by 190 during this time.
The year 2007 is used because in July 2008 VW announced they had selected the Hamilton county site and all incentives were in place before the announcement.
Local, state, and federal governments subsidized the project with an estimated $577 million, with 2,400 employees that comes to over $240,000 per employee.
 VW successfully pitted Tennessee against other states, I believe Alabama and Michigan in a bidding war for taxpayer dollars, VW won and Tennessee taxpayers lost. You can't blame VW, they had leverage and they used it, hold the politicians accountable.
The IDB doesn't need reformed, it needs to be eliminated along with PILOT agreements and all other forms of incentives.  
A part of the solution might be, if we are going to run 7th graders thru local factories and let them hear talking points from the Chamber of Commerce about the economic impact they have on the community lets also expose them to F.A. Hayek's "The Road to Serfdom" and Milton Friedman's " Free to Choose" so they can get at least get an idea what centralized planning does to an economy and what a free market system should really look like. Then maybe in 20 years all our elected officials won't be mouth pieces for the Chamber of Commerce.
Mike Lynn
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