Winning the Subsidy Game

By W. Zachary Malinowski

It seemed like the perfect match.

The winter of 2010 was a tough time for Rhode Island's then Gov. Donald L. Carcieri. His state had an unemployment rate hovering around 12 percent, among the highest in the nation, and several of his cities, including Providence, appeared on the verge of bankruptcy.

That March, Carcieri, a successful businessman before he entered politics, traveled to neighboring Massachusetts for a fundraiser at Curt Schilling's 25-acre estate in Medfield. Schilling, a star baseball pitcher, had become a folk hero in New England by leading the Boston Red Sox and their championship-starved fans to two world titles within four years.

Liberal New England didn't seem to care that Schilling was a conservative Republican who campaigned for President George W. Bush's reelection after the 2004 World Series. Carcieri, too, was a conservative Republican and he hit it off with the loquacious Schilling at the fundraiser.

Caricieri was searching for ways to pump life and new jobs into Rhode Island's economy, while Schilling was looking for big money and a place to land 38 Studios, his nascent start-up gaming company that featured his uniform number.

Massachusetts wasn't interested in expanding Schilling's business, but he captured the ear of Carcieri, the top executive of the nation's smallest state. Rhode Island has always had an inferiority complex and its elected officials tend to swoon over celebrities and high-profile athletes who are willing to spend time within its borders. 

Within months, Carcieri and Rhode Island's house speaker, Gordon Fox, a gay liberal Democrat, had joined forces to bring Schilling's new business to downtown Providence. The state, with the support of the Rhode Island Economic Development Corporation, issued $75 million in bonds to finance 38 Studios, a risky venture in the highly competitive world of video gaming. (The agency rebranded itself as the Rhode Island Commerce Corporation, effective in January.)

Fox told the Providence Journal that he was under intense pressure to bolster the Rhode Island economy. "We've got a 12 percent unemployment rate. We lost 32,000 jobs in the last couple of years. I'm a brand new speaker," he said. "Everybody's screaming about jobs. What are we going to do about this, short term?" 

Two years later, in May 2012, 38 Studios went belly-up, laying off 286 workers in downtown Providence and 100 in Maryland. Schilling said that 182 of the firm's employees lived in Rhode Island and earned an average salary of $86,000.

Post bust

Schilling, his business, and all of his employees are gone, but taxpayer rage remains towards the World Series hero and the state's poorly thought out, starstruck investment. A few months later, the newly comprised Rhode Island Economic Development Corporation (the EDC board members who approved the Schilling deal were axed and replaced) filed a lawsuit in the state Superior Court against Schilling; Keith Stokes, the EDC's executive director, who signed off on the scheme; and a host of other investors and law firms.

The state and current Gov. Lincoln Chafee, a Republican-turned-Independent and now a Democrat, was an outspoken critic of the $75 million bond deal when he ran for governor and was elected in 2010. He and other state leaders are attempting to recoup some of the millions that disappeared along with the All-Star pitcher's fledgling video-gaming firm. 

In the grand scheme of things, $75 million is not a huge sum of money when one looks at economic development loans and tax breaks designed to lure businesses in states such as Texas, Michigan, and New Jersey. But in Rhode Island, where the current budget is $8.2 billion, a loss of $75 million seriously wounds the local economy. It also restricts how much money is left to finance small businesses and start-up companies that are looking to launch or expand in the state.

An in-depth report released last summer by Good Jobs First, a nonprofit, nonpartisan watchdog group based in Washington, D.C., noted that state and local governments have awarded corporations more than $64 billion in subsidy packages "designed to encourage investment and the creation or retention of jobs" over the past 35 years. 

Michigan, home of the automotive industry, led the way with 29 megadeals, followed by New York, with 23, and Ohio and Texas, each with a dozen. Louisiana, Tennessee, Alabama, Kentucky, and New Jersey followed. A megadeal is one that involves a subsidy of at least $75 million.

The report notes that New York spent the most — $11.4 billion — and Michigan was next with $7.1 billion.

"Some of the deals involve little if any new-job creation; indeed, one in ten of the deals involves mere relocation of an existing facility, often within the same state and sometimes within the same metropolitan area," the report reads.

State and local governments are now adopting clawback provisions, designed to help taxpayers get relief from bad or failed subsidies that were handed out to businesses. The benefactors of the economic development loans include some of the nation's largest companies, Boeing, ExxonMobil, and Amazon.com among them.

Early deal

General Motors is another behemoth that has enjoyed subsidies for years. Its deals with Ypsilanti County, Michigan, date back to the 1970s.

In 1974, the state permitted local municipalities to offer tax abatements to businesses interested in creating or expanding the workforce with more jobs. Between 1975 and 1990, General Motors got sweeping tax abatements from the township that allowed the automotive manufacturer to get $1.3 billion in tax relief. In return, more than 13,000 jobs were created at two car production plants in the area.

But by the early 1990s, the relationship between the township and General Motors soured as the demand for the car being produced at both plants declined. In February 1992, GM officials decided to move its car production operation from the township to Arlington, Texas. Today, GM has a processing center in Ypsilanti that employs 115, just a shadow of the Willow Run plant that built transmissions and employed about 14,000 in the late '70s and as many as 4,000 in 2005.

The township sued in 1993, arguing that the car manufacturer took unfair advantage of generous tax abatements, but then broke its promise to remain in Michigan and employ thousands of workers. Doug Winters, the township's attorney, told the New York Times at the time: "We're (GM's) own private ATM. When they need money, they come begging, but when they don't want oversight, they say, 'get out of the way.'"

Initially, a trial court ruled in the township's favor, but that decision was reversed on appeal. "The fact that a corporation solicits a tax abatement and persuades a municipality with assurances of jobs is not evidence of a promise," the appeals court ruled. "The fact that a manufacturer uses hyperbole and puffery in seeking an advantage or concession does not necessarily create a promise."

It's big in Texas

Over the past three years, six companies in Oklahoma have laid off hundreds of workers while collecting millions of dollars in incentives to create more jobs. And there is no "clawback" provision that requires firms to repay the incentives if they drop workers from their payroll. Among the companies that have taken advantage of the program are Halliburton, the Houston-based defense contractor, and Spirit AeroSystems of Wichita, Kansas.

Halliburton has received $16 million since 1996 from the Quality Jobs Program in Oklahoma; Spirit AeroSystems has accepted $18.8 million in payments since 2007. Spirit announced last August that it plans to sell its Tulsa plant, which employs 2,800 workers.

In Texas, Gov. Rick Perry, a presidential candidate for the Republican Party in 2010, lobbied the state legislature to form the Texas Enterprise Fund. The fund was designed to use taxpayer dollars to help private companies create jobs. During the presidential primary, Perry boasted that the enterprise fund had awarded $440 million to create 59,157 jobs. But after taking a close look, the Austin American-Statesman newspaper concluded that the program had produced 30,700 jobs, 44 percent fewer than the governor had claimed.

Meanwhile, Texans for Public Justice, a watchdog group in Austin, reported even more alarming findings. The group attributed just 22,349 jobs to the Texas Enterprise Fund through the end of 2010. A November 2011 TPJ report added that, in 2010, 24 of the 65 projects, or 37 percent, failed to deliver on their original job promises. Perry's office terminated 11 failed projects prematurely, and five other projects falsely claimed they created more jobs than they actually did.

Among the companies that failed to fulfill their job creation promises were Lockheed Martin, Motiva, Tyson Foods, and Nationstar Mortgage. All told, the report concluded, the 24 companies were awarded nearly $84 million in enterprise funds but produced 5,044 fewer jobs than they had promised.

It also appears that politics came into play. For example, the McLane Group, a grocery wholesaler, received an enterprise award of $1 million in 2009 "to expand its conference, data, and software facilities in Temple," according to the Texans for Public Justice report. The company is owned by Drayton McLane Jr., an influential Texan who also owns the Houston Astros baseball team. McLane and his firm had contributed $261,126 to Perry's political campaigns from July 2001 through October 2010.

The McLane group had promised to create 225 jobs by 2011. Instead, the deal was terminated and the enterprise fund directed the company to repay the state $500,000 with 3.5 percent interest.

The TPJ report states that the enterprise fund has recovered $25.2 million of the $144 million in failed, nonperforming, or fraudulent loans that were distributed in 2010. That's a collection rate of 18 percent.

Craig McDonald, the director of TPJ, says that taxpayers would be better served if the state comptroller, instead of the governor's office, were making decisions on who should get loans and incentives to expand their companies. He credited his watchdog group and the news media for closely scrutinizing the loans. As a result, he says, there has been more accountability and caution in disseminating tax dollars.

"These contracts need to be more tightly written," McDonald says. "At least it's being discussed and the programs have been tightened up, so to speak."

Wishful thinking

But problems persist for taxpayers around the country.

In New Jersey, Gov. Chris Christie, often mentioned as a presidential candidate in 2016, overhauled the state's business subsidy system in the wake of Hurricane Sandy, which caused $68 billion in damages along the New Jersey coastline in October 2012. Christie opted to eliminate the Business Employment Incentive Program, the Urban Transit Hub Tax Credit, and the Business Retention and Relocation Assistance Grant tax credit. Now, all subsidies pass through the Economic Redevelopment Growth Grant and Grow New Jersey program.

Good Jobs First questioned the consolidation, saying there are not enough safeguards in place to limit state awards to businesses. Fiscal analysis of the bill conducted by the state's Office of Legislative Services concluded that "the bill will produce indeterminate multiyear state revenue loss," but it "cannot project the direction or magnitude of the bill's net fiscal impact on the state and local governments."

New Jersey has a $350 million cap on subsidies for each company, but the eligibility criterion has been eased, allowing firms a more direct path to getting the awards.

Clawbacks

Greg LeRoy, executive director of Good Jobs First, says that it's essential for state and local governments to negotiate safeguards that will protect taxpayers from defaults caused by risky loans.

"If it's an unsecured loan, then the state may lose everything or get a big haircut," he says. "The number of states with money-back guarantees is greater than it used to be, but I wouldn't say there has been a quantum leap," he adds.

In January 2010, LeRoy's group published a study, "Money-Back Guarantees for Taxpayers: Clawbacks and Other Enforcement Safeguards in State Economic Development Subsidy Programs," which reviewed 238 subsidy programs in the 50 states and the District of Columbia.

The study found that 215 of the programs, or 90 percent, require companies receiving subsidies to report to the state government on job creation or other initiatives. South Carolina and the District of Columbia had no performance verification in any of their five major programs.

The report also discovered that 178 of the programs include some type of penalty provision, including recouping benefits and altering or terminating future subsidies, but the penalties in nearly half of the programs were "discretionary rather than mandatory."

In recent years, California has awarded $490 million in subsidies or tax breaks for companies doing business in that state. Last year, the state legislature decided to adopt a series of steps that protects taxpayers from dubious investments. The change, which went into effect in January, requires detailed information, beginning and end dates for the subsidies, projected tax revenue, and a listing of all jobs that will be created, including full time, part time, and temporary.

Looking out for number one

On the local level, some cities have placed restrictions on how subsidies are awarded. Take Providence, Rhode Island. In January 2013, Mayor Angel Taveras, the state's first Latino mayor, overhauled the bylaws of the Providence Economic Development Partnership.

Under the new rules, staff members can no longer sign off on loans of $75,000 or less. Now, all loans must be approved by the 15-member board that Taveras chairs. The adoption of new rules came after the U.S. Department of Housing and Urban Development criticized the city for lacking "adequate oversight" and found that 60 percent of the loans the city issued between 2001 and 2011 were in default.

Scott Olson, a city councilor in Cedar Rapids, the second largest city in Iowa, is trying to put the brakes on city incentives that have helped private building projects that have sprung up after the devastating floods of 2008. Olson supports breaks for warehouse, office, and retail projects that move into Cedar Rapids, but he has questioned breaks for businesses that are moving within the city limits.

In Boston, Mayor Thomas M. Menino, who had been reluctant to grant tax incentives to Filene's Downtown Crossing, reversed his stance in September, agreeing to provide a $7.8 million tax deal for the $630 million project, which includes offices, stores, and up to 450 condominiums.

"That's a key development site," Menino told the Boston Business Journal. "Just think of the dollars it will bring into the city of Boston: sales tax, meals tax, heads on beds tax, all those taxes." But there are strings attached. The incentives will be spread over 13 years and will be assumed by office tenants and retail stores that agree to launch businesses on the property. A spokeswoman for the Menino administration said that the project will create nearly $60 million in new taxable property.

Cleaning up the mess

Back in Rhode Island, the state's lawsuit against Curt Schilling and his bankrupt 38 Studios video-gaming business continues to inch its way through the state court system. Schilling has returned to the public eye as a baseball analyst for ESPN, but the demise of his fledgling company has cost him about $50 million of his own money.

In recent months, he has placed his 8,000-square-foot home in Medfield, Massachusetts, on the market for $3.45 million. He has also sold — for $92,000 — the bloody sock that he gallantly wore in the 2004 come-from-behind playoff victory over the New York Yankees. Furniture, exercise equipment, a baby grand piano, and even artificial plants were up for grabs last October at an estate sale at his mansion.

The former baseball star has blamed Gov. Lincoln Chafee for failing to support his video-gaming business, while Chafee has claimed that Schilling hoodwinked state officials, leaving taxpayers on the hook for $75 million.

Last fall, Chafee sat down for an interview in his state house office and talked about 38 Studios and measures he and the general assembly adopted to tighten controls on subsidies and tax incentives. "It was a mix of everybody being badly burned by 38 Studios," Chafee says. "We didn't want that to happen again."

Among them are a $5 million cap on tax discounts for any new project that is launched in the state and regular evaluations that will be conducted by the department of revenue.

Chafee has a wealth of experience as a former city councilor and mayor in Warwick, Rhode Island, and as a U.S. senator. He said that he has always opposed subsidies for businesses on the local and state level. "Philosophically, I just don't like the deals," he says. "But I want to use the resources (with the $5 million cap) to at least be in the game."

Not everyone in the Rhode Island business community is thrilled with the belt-tightening measures that restrict economic development subsidies. In the spring of 2013, David C. Sweetser, a developer, sought $75 million in state assistance, city tax breaks, and historic tax credits to transform the iconic downtown Providence "Superman" building (which resembles the fictional Daily Planet building in the Superman comics) into 278 apartments, shops, and restaurants.

William Fischer, spokesman for the developer, which bought the building for $33 million in 2008, says that the project was a victim of the Schilling debacle. Sweetser's firm, High Rock Development LLC, didn't even bother applying for the $5 million in tax credits.

"I think that because of 38 Studios, it prevented a reasoned debate from unfolding," he says. "We were compared to handing $75 million to a baseball player with no prior business experience. That's the world we are working in now."

W. Zachary Malinowski is an investigative reporter for the Providence Journal.

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Resources

Illustration by Harry Campbell, www.harrycampbell.net.

The Good Jobs First reports can be found at www.goodjobsfirst.org.

A Pew Charitable Trusts report, "Evidence Counts: Evaluating State Tax Incentives for Jobs and Growth," is at www.pewstates.org/research/reports/evidence-counts-85899378806.

Texans for Public Justice: www.tpj.org