The District of Columbia has a number of powerful tools to promote economic development. For example, the Tax Increment Financing (TIF) and Payment in Lieu of Tax (PILOT) programs provide subsidies to commercial projects ‘ such as hotels or retail malls ‘ based on their potential for future revenues. Together, these programs are authorized to fund $1 billion in subsidies. Beyond these, the District offers a variety of tax incentives to encourage development.
These subsidies can be large. The Convention Center Hotel, which will be owned privately, is receiving nearly $170 million in subsidies. The DC USA mall being developed in Columbia Heights received more than $40 million. Last year, a new development at the Brentwood retail area ‘ where DC’s Home Depot is located ‘ received a 100 percent, six- year property tax abatement. (It is not clear how much this is worth.)
DC’s economic development programs thus have great potential to benefit the city. Yet in two key ways, these programs are not being used optimally:
- Lack of Focus on Creating Jobs for DC Residents: By and large, the District has used economic development to bolster certain industries ‘ such as promoting retail sales ‘ but job creation has not been a priority. Applications for economic development assistance are not judged on the number of jobs that will be created, or on the quality of those jobs. In addition, major economic development projects generally have not included training components to help DC residents get the jobs created, and the requirement that businesses receiving subsidies hire DC residents (known as “first source”) has not worked well.
- Failure to Adequately Account for Subsidy Costs: The District does not assess the amount it devotes to economic development subsidies in a comprehensive way, and it does not regularly evaluate the effectiveness of various programs. In addition, the District’s accounting for tax incentives often underestimates their costs. For example, the cost of a property tax break for development of vacant property is assessed based on the taxes currently paid instead of on the taxes that would be paid after the property is developed. Finally, fiscal impact statements often conclude that economic development subsidies have no effect on the city’s budget or pay for themselves by increasing tax revenues, even though in actuality they may have substantial costs.
This latter trend opens economic development programs to abuse. For example, legislation introduced in 2006 would have devoted $141 million toward a new central library, by issuing bonds that would be repaid with city tax dollars. Yet the fiscal impact statement for the bill concluded that it would have no effect on the budget, because it relied on financing from the economic development programs that are considered to have no fiscal effect.
DC policymakers and finance officials should consider a number of steps to address these shortcomings. To better use economic development programs to promote jobs and community benefits for DC residents, the District can:
- Apply DC’s living wage law to all recipients of economic development assistance, and work to improve the First Source hiring requirement. DC passed a living wage requirement in 2006, requiring DC contractors and some recipients of economic development assistance to pay their workers at least $11.75 an hour. The living wage helps ensure that DC’s economic development investments create good-paying jobs. But the law does not cover all subsidy recipients, particularly recipients of tax abatements. Moreover, the District currently requires businesses getting subsidies to hire DC residents for a majority of the new jobs, but this requirement often is not met.
- Require businesses seeking subsidies to identify the number of jobs that will be created and the wages and benefits associated with those jobs. This will give the District an important way to evaluate proposed subsidies. In addition, businesses should agree to meet the job creation targets and face a “clawback” of the subsidy if the target is not met.
- Include a training component for all major projects. The subsidy for the Convention Center Hotel includes $2 million to train neighborhood residents for hotel jobs. This provides a good model for future development projects.
- Target a portion of subsidy programs to neighborhoods with high poverty levels.
To improve the way the District accounts for the fiscal effect of economic development tax incentives and subsidies, it can:
- Develop an annual “economic development budget” to track all spending and tax subsidies used for economic development. This would provide a comprehensive picture of the resources devoted to economic development. In addition, the city could develop a process to evaluate how well tax incentive programs work ‘ like a tax break to spur construction of grocery stores. Finally, it could include a “sunset” provision for all tax incentives, forcing the Council and Mayor to review the effectiveness on a regular basis.
- Require an analysis from the CFO of the likelihood that development will occur in a given area if no subsidy is provided. This would help policymakers focus on projects and sites that would not be developed “but for” the subsidy.
- Require full accounting of the costs of subsidies. The costs or benefits of economic development incentives should be derived by comparing the revenues that would be collected after the subsidy is taken into account with the likely revenues that would be expected if the subsidy is not provided.
Issue I: Using Economic Development Programs to Promote Jobs and Community Benefits
There are many signs that the District’s economy is far stronger today than it was a decade ago: a robust real estate market, a string of annual budget surpluses, and a resurgence in DC’s population. Since the late 1990s, the number of jobs in the District has increased and household incomes are up.
At the same time, there also are many signs that economic progress has left many DC residents behind. While the number of jobs within DC’s boundaries increased by 30,000 between 2000 and 2005, the number of working DC residents fell by 15,000. DC’s unemployment rate is higher than in most large cities, and this is especially troubling considering that the entire metro area has one of the lowest unemployment rates in the nation. Despite this strong economy, the number of DC residents living in poverty rose by 11,000 last year.
For these reasons, improving access to jobs with good wages and benefits should be a priority of the District. One way to meet these goals is to use the city’s economic development programs as a tool for job creation using the following steps:
Set wage and benefit standards for all economic development programs. In 2006, the District adopted a living wage law, which requires government contractors and some businesses getting certain kinds of economic development assistance to pay their workers at least $11.75 per hour. This is an important way to ensure that economic development programs result in good jobs for DC residents. Setting wage requirements also encourages the District’s economic development officials to seek projects and businesses that will bring desirable jobs.
The living wage requirement does not apply, however, to all economic development programs. TIF recipients must pay the living wage to construction workers and to all direct permanent employees of the project. But if the owner leases space, tenants are not required to pay the living wage. For example, the DC USA retail mall being developed in Columbia Heights received more than $40 million in development subsidies. The living wage requirement does not apply, however, to any of the mall’s future tenants, including Target and Bed, Bath and Beyond. Instead, it will apply only to workers employed by the mall owner, such as security and custodial staff.
In addition, the living wage requirement does not apply to businesses receiving tax incentives. A new retail Center at the Brentwood shopping center received a six-year property tax abatement, but this kind of assistance does not trigger DC’s living wage requirement.
DC’s living wage law would be strengthened greatly by extending it to all permanent employees in a subsidized project, including those who work for tenants in the development, and to recipients of all forms of economic development assistance.
Evaluate Economic Development Proposals Based on Job Creation Potential. In general, job creation has not been the central focus for recent economic development projects in DC. The District could modify its major economic development programs to require businesses seeking subsidies to specify the number of new jobs that will be created ‘ both construction jobs and permanent jobs once the project is completed ‘ as well as the expected wages and benefits for those jobs. This information could be made public and included in DC Council hearings on proposed subsidies.
This would allow the Mayor and Council to evaluate and compare various proposals for subsidies based on their job creation potential. A project seeking $10 million to create 100 jobs ‘ or $100,000 per job ‘ would be less worthwhile from this perspective than a project seeking $2 million to create 50 jobs ‘ or $40,000 per job. The District could go a step further and limit subsidies to no more than a certain amount per new job created.
To make these job creation targets real, they would have to be included in economic development agreements, and the agreements would have to include a “clawback” provision to reclaim some or all of the subsidy if the job creation targets are not met. If only half of the promised jobs are created, for example, up to half the subsidy could be reclaimed.
These techniques are increasingly being used to make economic development programs more productive and accountable. Some 20 states, for example, include clawback provisions in at least some economic development programs.
Include a training component for all major projects. The Convention Center Hotel, which will be owned and operated privately, is receiving $170 million in Tax Increment Finance assistance. This will cover roughly one fourth of the project’s costs. Of the TIF subsidy, $2 million has been set aside to train neighborhood residents for the new hotel’s jobs. This community benefit was sought and secured by ONE DC, a grassroots organizing group in the Shaw neighborhood of DC.
The District currently does not require a training set-aside for all economic development subsidies. Establishing such a requirement for all subsidies above a certain size would be a practical way to ensure that economic development projects result in benefits for DC residents.
Work to improve the First Source hiring requirement. Businesses that get economic development subsidies from the District are required to hire at least 51 percent of their new workers from the District. Unfortunately, DC’s First Source program has not worked well. For example, just one-third of workers at DC’s Mandarin Hotel ‘ which received nearly $50 million in city subsidies ‘ are DC residents. Many employers argue that it is difficult to find qualified DC residents and that the Department of Employment Services does not help businesses identify qualified employees. At the same time, DOES does not enforce First Source vigorously and has never fined a business for failure to comply. This suggests that First Source is not serving its intended purpose.
District leaders should work to improve the functioning of First Source ‘ both by helping identify qualified DC residents for job openings created through businesses with First Source requirements and by monitoring and enforcing First Source agreements.
Target a portion of subsidy programs to neighborhoods of high poverty. In many states and cities, some economic development programs are targeted on areas of blight or high poverty. This helps ensure that subsidies are targeted to areas where private investment is weak and that new jobs will be accessible to residents of poor neighborhoods. The District could modify its major subsidy programs to require that a specified portion be targeted on neighborhoods of high poverty.
Issue II: Develop an Annual “Economic Development Budget” to Track Spending and Tax Subsidies Used for Economic Development
The District has many tools to promote economic development. Many of them are tax-related, including targeted tax breaks to encourage certain kinds of development. Although they are provided as tax reductions, the impact of these subsidies on DC’s budget is no different from the impact of programs that involve direct expenditures for services. In both cases, the programs reduce revenues available for other purposes.
The District’s budget does not adequately track the full impact of economic development programs on the city’s finances. Moreover, there is little scrutiny of the costs or impacts of tax subsidies. And unlike on-budget programs, where the appropriation must be justified every year in the budget process, tax subsidies typically continue indefinitely without much review of their effectiveness.
The District can address these issues in two ways: by developing an annual budget to track total revenues devoted to economic development activities, and by requiring that all tax subsidies “sunset” or expire after a certain period of time, so that the Mayor and DC Council can review the effectiveness of the subsidy before renewing it.
Developing an Annual Economic Development Budget
Every two years, the District publishes a “tax expenditure” budget to track programs that are provided through the tax code. One example is a sales tax exemption for materials used to build grocery stores in low-income DC neighborhoods. The financial subsidy provided through this tax incentive is no different than if the District would make direct payments to a developer to cover some of the costs of construction. The Earned Income Tax Credit is another example of a tax expenditure. The EITC, a credit for low-income workers, provides a financial boost to help the working poor make ends meet.
DC’s tax expenditure budget helps identify tax-based subsidies used for economic development (as well as for other purposes). Yet these kinds of tax incentives represent only a fraction of the city’s economic development programs. Other elements that are not reflected in the tax expenditure budget include:
- Tax Increment Financing: Under TIF, developers can receive a subsidy to complete a project if they can demonstrate that the project will generate tax revenue that equals the subsidy cost. The TIF program can support up to $500 million in subsidies.
- Payment in Lieu of Tax (PILOT): Properties that have been tax-exempt but that are being converted to taxable uses are eligible for the PILOT program. This includes federal lands that are transferred to the District for private development. Under PILOT, the property taxes that the new private owner would pay can be diverted to support development of the new owner’s property, rather than going into DC’s general fund as property taxes normally do. In 2006, for example, the District approved PILOT payments to help develop the area around the new Southeast Federal Center. The PILOT program also can support up to $500 million in subsidies.
- Ad hoc tax subsidies. The District sometimes creates special tax breaks to support a specific development. In 2004, for example, the city approved a $4 million tax break for a developer of housing and a grocery store on Capitol Hill. In another example, the District approved a property tax abatement for the owners of the American Psychology Association building, in return for a pledge to hold its tri-annual meeting in DC.
- The Capital Budget: Some economic development assistance is provided through an appropriation of funds in DC’s capital budget, which supports construction and renovation projects. For example, the FY 2007-2012 six-year capital plan includes funding to support redevelopment of the Old Convention Center site.
While information on the cost of individual subsidies may be available, the DC budget does not collectively track the amounts devoted from various programs to economic development. As a result, it is more difficult to track how much DC spends on economic development than on other basic functions, such as public safety.
One way to address this is to create an annual economic development budget that identifies the amount spent on each economic development subsidy in the past year, as well as projected amounts to be spent in the upcoming year. This would allow policymakers and the public to assess the size of DC’s economic development activities and thus to better make decisions about the amount of DC resources that should be devoted each year to economic development.
Create Sunset Provisions for All Tax Expenditures
Many government programs are authorized only for a specified number of years. A so-called “sunset” provision gives policymakers a chance to review a program’s design and effectiveness. Ongoing scrutiny also can occur through the budget process, where each program’s funding is reviewed and must be justified each year.
Tax expenditures, however, often do not receive that level of scrutiny. They are not reviewed and approved each year in the annual budget, and many have no sunset provisions and thus continue on indefinitely.
The District already has taken one important step to scrutinize tax expenditures, by requiring the CFO to prepare a tax expenditure budget every two years that estimates the revenue lost from each tax expenditure. The District has not, however, put a sunset provision in each tax expenditure. As a result, many tax breaks have continued without any assessment of the impact. There is no information, for example, on how well the grocery store tax exemption or a tax incentive for high-technology businesses have worked to lure such businesses to DC.
Adding a sunset provision to every tax expenditure program would force these questions to be asked on a regular basis, allowing the District to modify tax expenditures to make them more effective or eliminate those that have proven ineffective.
Issue III: Improve the Accounting for the Costs of DC Tax Subsidies
Many of the District’s tools to promote economic development come in the form of tax incentives. These subsidies reduce available revenues and thus have a real impact on the District’s finances. In some cases, DC’s economic development programs create long-term commitments to specific projects and thus reduce revenues for several years. For these reasons, it is critically important to account for the fiscal effect of economic development programs.
DC’s current accounting for tax incentives, however, often underestimates their costs, which means that these subsidies have a far greater effect on DC revenues than official estimates show. For example, the fiscal effect of a property tax break for a hotel built on vacant land is based on taxes currently paid on the vacant land, instead of on the taxes the hotel would pay without the tax break. In addition, major subsidy programs, such as Tax Increment Financing are considered to have no fiscal effect whatsoever, even though in actuality they may reduce revenues substantially.
The under-estimated costs of economic development programs create the potential for abuse. In 2006, for example, a bill before the DC Council would have devoted $141 million toward a new central library. While library construction normally would be part of the city’s capital construction budget and the costs would be fully reflected there, the library financing bill relied on a variety of economic development programs ‘ with the result that the CFO concluded that the bill would have no effect on DC’s budget or finances. In essence, the costs of the bill were hidden.
This example highlights the importance of improving the accounting of the costs of economic development programs and to use these programs judiciously.
Improved Accounting Needed for the Costs of Tax Subsidies
The current method for measuring the impact of tax subsidies often does not fully assess the impact on DC’s revenues.
Consider, for example, a 10-year property tax abatement offered to a developer to build a hotel on land that currently is vacant. The vacant land currently provides very little tax revenue, but it would provide substantial tax revenue once developed. In assessing the fiscal effect of property tax abatements such as this, however, the District’s Chief Financial Office considers only the loss of taxes currently paid on the vacant land ‘ not the higher taxes that would be paid by the hotel. If taxes on the vacant land are $500,000 but the hotel would pay $2 million in property taxes when developed, the fiscal impact is set at $500,000. Yet the loss of revenue to the city is $2 million.
This is not hypothetical. In 2005, the DC Council awarded a six-year property tax abatement for the developer of a retail strip in the Brentwood area, near Home Depot. The CFO’s fiscal impact statement found that the tax abatement would have no effect on DC’s finances, even though the District would have collected substantial tax revenues from the development without the subsidy.
The 2006 library bill provides another example. Some $40 million in that bill’s funding would have come from tapping tax revenues generated by future businesses on the Old Convention Center site. The site is now a publicly owned parking lot and generates no tax revenue. The District plans to lease much of that land for private development, which means that it will generate substantial tax revenues in the future. Because the site currently generates no taxes, the District’s Chief Financial Officer concluded that tapping the future revenues for library construction would have no impact on DC’s budget. Yet clearly this action would have reduced the city’s future revenues by $40 million.
TIF and PILOT Programs Officially Have No Costs But in Actuality Can Limit DC Revenue Growth Substantially
The District’s two largest economic development programs are Tax Increment Financing (TIF) and Payments in Lieu of Tax (PILOT). Together, they are authorized to support over $1 billion in economic development projects. Under the current accounting methods for these programs, however, each TIF or PILOT project is considered to have no impact on DC’s finances.
Under Tax Increment Financing, subsidies are awarded to commercial developments that are projected to generate substantial new, or “incremental” tax revenues. The new taxes are used to offset the cost of the upfront subsidy. Because it is structured in this way, TIF is often viewed as a program that pays for itself.
This logic only makes sense, however, if it is likely that no development would occur on a given site without a TIF subsidy. In that situation, the new taxes from the completed project really would be new revenues that the city would not otherwise have. In many communities across the country, TIF subsidies are targeted to areas defined as blighted for this reason.
DC’s TIF program, however, has no blight requirement. In several instances, TIF has been in DC to build in DC’s business core. For example, the District awarded a $74 million TIF subsidy for a housing and retail development at Gallery Place. District officials expected the area to develop as office space and used TIF to encourage retail and housing instead. The site would have generated substantial new tax revenues even without the subsidy, which means that the Gallery Place TIF subsidy cannot be said to be generating new tax revenues for the city. In reality, the Gallery Place TIF was a $74 million public expense to shape economic development.
The Payment in Lieu of Tax (PILOT) program is tied to properties that currently are exempt from property taxes, such as DC- or federally-owned land that is being converted to private use. The old Convention Center site is an example. Under PILOT, the property remains tax-exempt when it is converted to private use and the owner makes a payment in lieu of tax instead. The PILOT payments are used to support the private development on that land. (More specifically, the city issues bonds to support the development, and the PILOT payment is used to repay the bond.)
In 2006, for example, the city approved a PILOT to support the development of the Arthur Capper/Carrolsburg project, which is converting a public housing development into a mixed income development. The property taxes that would be paid by the owners of land on that site will be converted to a PILOT payment that will be used to support the project’s development.
Because PILOTs can be used only for properties that were tax-exempt and producing no revenues, the diversion of property tax payments from the new private owners is considered to have no fiscal effect. Yet PILOT agreements divert funds that otherwise would go to the District’s general fund. This is important, because maintaining strong revenue growth over time requires regular additions of new revenue-generating economic activity. If a substantial share of potential new revenues sources are used instead for PILOT projects, it would limit the city’s long-term revenue growth.
The Solution: Improved Accounting for Tax Subsidies
There are two steps the District can take to improve the way it determines the impact of tax subsidies on the city’s finances.
Require an analysis from the CFO of the likelihood that projects will be developed if no subsidy is provided. This analysis could be split into two parts. The first part would be to determine the likelihood that a proposed project could be developed with private financing only. For example, the CFO could assess the possibility that a hotel large enough to meet the needs of the Convention Center would be developed privately. This would help policymakers focus on projects that would not go forward “but for” the subsidy.
The second part of this analysis would be to assess the likelihood that a given site would be privately developed for alternate purposes if the proposed project does not go forward. In the case of the Convention Center Hotel, the CFO would assess the likelihood that the proposed parcel would be developed for another purpose, such as office space, if not developed as a hotel. This is important because it would help policymakers understand whether the proposed project, in reality, would create new development and bring in new tax revenues that the city otherwise would not collect.
Measure the fiscal effect of tax subsidies by comparing the revenues the city will collect after the subsidy with the revenues that would be collected if no subsidy were provided. As noted earlier, when the District provides property or other tax abatements for new developments, the CFO’s fiscal impact statement only takes into account the loss of taxes currently paid on the undeveloped land. A better measure of the full fiscal impact would take into account the taxes that the new owner would pay on the fully developed project without the tax abatement.
This method should apply to TIF and PILOT projects as well. In the case of TIF, the CFO should determine what would likely happen to the site if the TIF subsidy is not approved. Would the proposed project likely go forward as is? Would the land remain undeveloped? Or would it be developed for another use? The fiscal effect of the TIF would reflect the difference between A) the taxes that would be generated by any development that would be expected in the absence of the TIF and B) the taxes that will be raised under the TIF-subsidized project. If the TIF does not generate any truly incremental revenue, the TIF subsidy would be considered an expense that would have to be factored into the budget.
In the case of the PILOT program, a similar analysis could be made. The CFO could determine the property taxes, if any, that would be collected if the PILOT agreement is adopted, and the property taxes that the developer would pay without the PILOT agreement. If the CFO determines that the project could go forward without the subsidy, then the full amount of the PILOT would be considered an expense. If it is determined that the site would remain undeveloped without the PILOT subsidy, then diverting the new property tax payments to a PILOT would not negatively affect DC’s finances.