Properly Using & Analyzing Properly Using & Analyzing Incentives & Performance Incentives & Performance AgreementsAgreements

APPA 2006 Community & Economic APPA 2006 Community & Economic Development ConferenceDevelopment Conference

Presented by: Presented by:

Chip GerhardtChip GerhardtVice PresidentVice PresidentKMK Consulting Company, LLCKMK Consulting Company, LLCCincinnati, OhioCincinnati, Ohio

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BackgroundBackground

Highly competitive market between jurisdictions to attract Highly competitive market between jurisdictions to attract and retain companies, jobs and associated capital and retain companies, jobs and associated capital investment investment – Everyone fighting to create the best incentive programsEveryone fighting to create the best incentive programs– Incentive packages have continued to grow in volume Incentive packages have continued to grow in volume

and monetary valueand monetary value

Companies forced to assess long-term feasibility of U.S. Companies forced to assess long-term feasibility of U.S. operations due to global cost constraintsoperations due to global cost constraints

Corporate executives placing more emphasis on incentive Corporate executives placing more emphasis on incentive packages as they consider expansion and/or relocation packages as they consider expansion and/or relocation strategies. strategies. – Area Development Magazine’s Annual Corporate Survey Area Development Magazine’s Annual Corporate Survey

ranks state and local incentives the #4 factor in the site ranks state and local incentives the #4 factor in the site selection decision-making process. selection decision-making process.

Over half of respondants cite incentives as “very Over half of respondants cite incentives as “very important” and almost another third view them as important” and almost another third view them as “important”“important”

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Typical IncentivesTypical Incentives Real & personal property tax exemptionsReal & personal property tax exemptions

Corporate tax creditsCorporate tax credits

Sales tax creditsSales tax credits

Low-interest financingLow-interest financing

Tax exempt or taxable bond financingTax exempt or taxable bond financing

Tax Increment Financing (TIF) Tax Increment Financing (TIF)

Sale-lease back agreements Sale-lease back agreements

Job training grantsJob training grants

Grants to offset the purchase of new machinery or Grants to offset the purchase of new machinery or equipment equipment

Roadwork/Infrastrusture improvement grantsRoadwork/Infrastrusture improvement grants

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Typical IncentivesTypical Incentives Performance vs. Direct SubidyPerformance vs. Direct Subidy

– Trend is to use more performance-based incentives Trend is to use more performance-based incentives Partly because of increased scrutiny and changing Partly because of increased scrutiny and changing

economy (manufacturing to high-tech, service economy (manufacturing to high-tech, service economy)economy)

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Role of IncentivesRole of Incentives Inducement vs. Entitlement Inducement vs. Entitlement

– Eligibility requirements: years of operation, number of jobs created, Eligibility requirements: years of operation, number of jobs created, capital investmentcapital investment

What policy issue/problem is the incentive designed to address?What policy issue/problem is the incentive designed to address?

““But for” clauseBut for” clause– Is there competition or is it a done deal?Is there competition or is it a done deal?– Difficult to determine whether “real” competition existsDifficult to determine whether “real” competition exists

Are you willing to call their bluff?Are you willing to call their bluff?

Attracting new business vs. retaining existing business Attracting new business vs. retaining existing business – Approximately 85% of all new job growth in a given community is Approximately 85% of all new job growth in a given community is

from existing businessfrom existing business Little fanfare from media or government for existing businessesLittle fanfare from media or government for existing businesses Political pitfalls for job retention effortsPolitical pitfalls for job retention efforts

– Only so many big deals at a time so only a few communities can winOnly so many big deals at a time so only a few communities can win Time, energy and money spent wooing the “whale” Time, energy and money spent wooing the “whale”

– Negative response from existing businessNegative response from existing business Loyal corporate citizen, pay 100% of my taxes, regularly adding Loyal corporate citizen, pay 100% of my taxes, regularly adding

good paying jobs, what about me?good paying jobs, what about me?

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Return On InvestmentReturn On Investment Government’s calculationGovernment’s calculation

– Fincancial models often useful but cannot predict the futureFincancial models often useful but cannot predict the future– How much public money is being allocated to generate each job/dollar of How much public money is being allocated to generate each job/dollar of

investment?investment? Direct investment- grants, abatements, credits, etc.Direct investment- grants, abatements, credits, etc. Indirect investment- infrastructure capacity increases with increased Indirect investment- infrastructure capacity increases with increased

demand, public services increases with increased populationdemand, public services increases with increased population– Policy decision to determine what the numbers need to bePolicy decision to determine what the numbers need to be– Does the government need to make money on the deal?Does the government need to make money on the deal?

Taxes accruing to government from business and its employeesTaxes accruing to government from business and its employees– Sales TaxSales Tax– Use TaxUse Tax– Motor Fuel TaxMotor Fuel Tax– Cigarette TaxCigarette Tax– Spirits TaxSpirits Tax– Table Wine TaxTable Wine Tax– Beer TaxBeer Tax– Corporate Franchise TaxCorporate Franchise Tax– Corporate Income TaxCorporate Income Tax– Real Property TaxReal Property Tax– Public Utility Personal Property TaxPublic Utility Personal Property Tax– Tangible Personal Property TaxTangible Personal Property Tax– Employee Withholdings Tax Employee Withholdings Tax – Estate TaxEstate Tax

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ROIROI City of Cincinnati Riverfront TIF District ExampleCity of Cincinnati Riverfront TIF District Example

– Total TIF District value: $725,649,650 (total market value less Total TIF District value: $725,649,650 (total market value less abated/exempt parcel value) abated/exempt parcel value)

– 30 yr threshold value (amount of loss that must be recovered by 30 yr threshold value (amount of loss that must be recovered by increases in state tax revenues generated by TIF district): increases in state tax revenues generated by TIF district): $10,300,169$10,300,169

– 30 yr new state tax revenue (generated as a result of TIF 30 yr new state tax revenue (generated as a result of TIF district): $216,783,423district): $216,783,423

Projects create buzz for communityProjects create buzz for community– Reinforces real/perceived strength of a community in the eyes of Reinforces real/perceived strength of a community in the eyes of

site selectors and other decision makers site selectors and other decision makers – Lands community on the radar screeenLands community on the radar screeen– PR goldmine: awards, rankings, etc. PR goldmine: awards, rankings, etc.

Impact of development on quality of lifeImpact of development on quality of life– Community involvementCommunity involvement– Investment in community assets Investment in community assets

Secondary developmentSecondary development– Vendor/supplier networkVendor/supplier network

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Company CommitmentsCompany Commitments

Location of project Location of project – Site/address specificSite/address specific

Timing of projectTiming of project– Must be completed in 3 yrsMust be completed in 3 yrs

Jobs to be createdJobs to be created– Net new jobs (total & number of employees from within Net new jobs (total & number of employees from within

jurisdiction)jurisdiction)– Average wage & benefits (new payroll)Average wage & benefits (new payroll)– Minority/disadvantaged personsMinority/disadvantaged persons

Jobs to be retainedJobs to be retained– Number of jobsNumber of jobs– Existing payroll Existing payroll

Capital investment Capital investment – LandLand– BuildingBuilding– Construction costsConstruction costs– Machinery & equipmentMachinery & equipment

Letter of credit, collateral, personal guarantee (in case of loan)Letter of credit, collateral, personal guarantee (in case of loan)

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Government CommitmentsGovernment Commitments

Type of incentive (grant, loan, tax credit, tax Type of incentive (grant, loan, tax credit, tax abatement, etc) abatement, etc)

Value of incentives (rate & term)Value of incentives (rate & term)

Permitting assistancePermitting assistance

Workforce issues (i.e. partner with regional job center, Workforce issues (i.e. partner with regional job center, screen candidates)screen candidates)

Legislative support (any changes needed to state/local Legislative support (any changes needed to state/local law to make the close the deal) law to make the close the deal)

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ComplianceCompliance Major issue that is not often or seriously enough considered by Major issue that is not often or seriously enough considered by

company when negotiating incentivescompany when negotiating incentives

Annual ReportingAnnual Reporting– Mandatory filing to be eligible for incentive Mandatory filing to be eligible for incentive – Maintains accurate record of project Maintains accurate record of project – Filing includes: Filing includes:

Jobs created & associated payroll/benefitsJobs created & associated payroll/benefits Jobs retained & associated payroll/benefitsJobs retained & associated payroll/benefits Capital investmentCapital investment

Clawback provisionsClawback provisions– Contractual benchmarks for projectContractual benchmarks for project– Percentage of incentive at risk if benchmarks/commitments are Percentage of incentive at risk if benchmarks/commitments are

not metnot met Usually on a sliding scaleUsually on a sliding scale Often at discretion of authority or governing body to issue Often at discretion of authority or governing body to issue

waiver for one-time default as a result of market conditionswaiver for one-time default as a result of market conditions Company can voluntarily withdraw from program to avoid Company can voluntarily withdraw from program to avoid

ongoing filing and non-complianceongoing filing and non-compliance Government can cancel agreement if company in non-Government can cancel agreement if company in non-

compliance for extended period of timecompliance for extended period of time

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ComplianceCompliance Can become complicated processCan become complicated process

– Needs to be a clear, Needs to be a clear, mutualmutual understanding of what needs understanding of what needs to be reported and when for company to receive full to be reported and when for company to receive full benefit of incentive packagebenefit of incentive package

Statute vs. policyStatute vs. policy Both business and government representatives have Both business and government representatives have

long memorieslong memories– Hesitency to consider company/jurisdiction for Hesitency to consider company/jurisdiction for

the next projectthe next project– Voluntarily withdraw from program to Voluntarily withdraw from program to

shorten/reduce compliance periodshorten/reduce compliance period– Political fallout if/when benchmarks not metPolitical fallout if/when benchmarks not met

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Public RelationsPublic Relations Government Government

– Need to maintain public trustNeed to maintain public trust Taxpayer dollars being usedTaxpayer dollars being used Why not me?Why not me? Ethical concerns Ethical concerns Philosophical debate on whether incentives really Philosophical debate on whether incentives really

work- are they critical to attracting/retaining jobs and work- are they critical to attracting/retaining jobs and investment?investment?

BusinessBusiness– Need to maintain long-standing position in the Need to maintain long-standing position in the

community/goodwillcommunity/goodwill– Do not want to be perceived as holding jurisdiction Do not want to be perceived as holding jurisdiction

hostage for payoffhostage for payoff– Focus on the positive elements of the project (jobs, Focus on the positive elements of the project (jobs,

investment, economic impact)investment, economic impact)

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On-Going Review of IncentiveOn-Going Review of Incentive Is the policy issue that the incentive was originally designed to address still Is the policy issue that the incentive was originally designed to address still

present or has the landscape changed?present or has the landscape changed?– Adjustments to the tax codeAdjustments to the tax code

Ohio Ohio – Ohio’s Commerical Activity Tax (CAT)Ohio’s Commerical Activity Tax (CAT)

Tax on gross receipts (sales, performance of services, rentals/leases) Tax on gross receipts (sales, performance of services, rentals/leases) Retailers are the biggest losersRetailers are the biggest losers

– Phase out of corporate franchise tax (5 yrs, 20% per); phase out of personal Phase out of corporate franchise tax (5 yrs, 20% per); phase out of personal property tax (4 yrs, 25% per); 21% reduction in state income tax from 2004 (4 property tax (4 yrs, 25% per); 21% reduction in state income tax from 2004 (4 yrs); State sales tax reduced to 5.5%yrs); State sales tax reduced to 5.5%

– Transition from old economy, hourly wage, manufacturing workers to new Transition from old economy, hourly wage, manufacturing workers to new economy, salaried service/R&D/high-tech employees economy, salaried service/R&D/high-tech employees

Are the expectations for particular programs realistic?Are the expectations for particular programs realistic?

Are there enough resources being used to maximize value of the incentive?Are there enough resources being used to maximize value of the incentive?– Who is the target audience and how are you reaching them? Who is the target audience and how are you reaching them? – What happens when you throw a party and no one shows?What happens when you throw a party and no one shows?

DaimlerChrysler Corp. vs. CunoDaimlerChrysler Corp. vs. Cuno– Lawsuit regarding Ohio’s ability to offer machinery and equipment tax Lawsuit regarding Ohio’s ability to offer machinery and equipment tax

creditcredit– 66thth Circuit Court of Appeals upheald ruling that the incentive violating the Circuit Court of Appeals upheald ruling that the incentive violating the

Commerce Clause of the U.S. ConstitutionCommerce Clause of the U.S. Constitution– U.S. Supreme Court vacated the decision saying that the Ohio & Michigan U.S. Supreme Court vacated the decision saying that the Ohio & Michigan

taxpayers did not have standing to challenge use of incentive taxpayers did not have standing to challenge use of incentive

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Example: Honda Assembly Example: Honda Assembly PlantPlant Greensburg, Indiana won the projectGreensburg, Indiana won the project

– 1,700 acres between Indianapolis and Cincinnati, Ohio 1,700 acres between Indianapolis and Cincinnati, Ohio – Illinois, Michigan, Ohio and Wisconsin also competed for projectIllinois, Michigan, Ohio and Wisconsin also competed for project

Benefit to IndianaBenefit to Indiana– $550 million development $550 million development – 2,000 employees2,000 employees– Plant will eventually produce 200,000 new vehicles annuallyPlant will eventually produce 200,000 new vehicles annually

Cost to IndianaCost to Indiana– $41.5 million in direct incentives to Honda $41.5 million in direct incentives to Honda

Up to $22 million: EDGE credits (% of payroll tax withholding for net new IN jobs)Up to $22 million: EDGE credits (% of payroll tax withholding for net new IN jobs) $1.5 million: training $1.5 million: training Up to $18 million: property tax abatementUp to $18 million: property tax abatement

– $44 million in on-site infrastructure improvements$44 million in on-site infrastructure improvements $28 million: road improvements$28 million: road improvements $11 million: water utility infrastructure$11 million: water utility infrastructure $5 million: wastewater utility infrastructure $5 million: wastewater utility infrastructure

– $56 million in regional infrastructure improvements $56 million in regional infrastructure improvements $35 million: road improvements$35 million: road improvements $13 million: water utility infrastructure$13 million: water utility infrastructure $8 million: wastewater utility infrastructure$8 million: wastewater utility infrastructure

Not all losersNot all losers– Supplier network outside Indiana to benefit Supplier network outside Indiana to benefit

$1.5 billion in new business, of which $1 billion will be in Ohio$1.5 billion in new business, of which $1 billion will be in Ohio– 1,000 new jobs and $100 million in new investment1,000 new jobs and $100 million in new investment

Q & AQ & A

Chip Gerhardt Vice President

KMK Consulting Company, LLC1 East 4th Street

Suite 1400Cincinnati, Ohio 45202

(513) 579-6548cgerhardt@kmkconsulting.com