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While no one would deny that the delivery of core services is the most important function of local governments, many would also admit to the politically seductive nature of economic development. The appeal of adding jobs and income is strong, and a healthy economy is an important attribute for any community. That's why nearly all local governments pursue economic development in some form.
There are different approaches to encouraging economic development. One is the laissez-faire approach, in which governments limit their intrusion into the private market. Many large cities, however, do not strictly adhere to this approach: Witness the growth in tax increment financing, property tax abatements, tax credits, and exemptions for economic development. These state and local incentives amounted to more than $50 million in 2002. (1)
The purpose of this article is not to debate whether incentives should be offered, but to provide considerations in analyzing the costs and benefits--the fiscal impacts--of economic development projects. The article also provides an overview of an economic impact analysis (due to space limitations, only the most important elements will be discussed).
THE SIX ANALYTICAL STAGES
Fiscal impact analysis measures the direct public revenues and costs engendered by a development. This article will concentrate on six analytical stages:
* Determine applicable revenues
* Develop or verify economic assumptions
* Account for economic displacement effects
* Consider opportunity costs
* Calculate the cost of economic development
* Account for the time value of money
Determine applicable revenues. The first step is to determine what revenues will accrue to the local government as a result of a new development. These may consist of directly collected revenues and/or some collected by the state, or other entity, and remitted to the locality. Examples include real estate, business personal property, gross receipts, state sales, lodging, rental car, restaurant meals, admissions, utility, local income, and capital stock or net worth tax.
Develop or verify economic assumptions. While identifying revenues subject to local taxation is relatively easy, quantifying them is not always so simple. Where developers seek some form of a public incentive or require public approval (e.g., land rezoning), they typically supply the proposed economic development estimates (e.g., gross sales). These estimates may reflect the developer's best approximation, but a financial analyst should be attentive to the possibility that such numbers may be optimistic. The question, then, is how the analyst is to go about verifying the estimates, or developing estimates if none were supplied. (2)
By using local tax data or national sources, an analyst can verify some economic estimates by comparing proxy estimates of sales per square feet for businesses that are similar to the proposed development. If a locality imposes a gross receipt, business personal property, meal, and/or hotel tax, then a governmental agency is responsible for collecting the tax levy. While disclosure of a single entity's tax revenue may be proprietary information, an analyst may be able to obtain aggregate tax data from the local tax office for a group of establishments within a business classification (aggregate tax data do not constitute a breach of confidentially).The exterior square footage of commercial properties is public information that is available through the local real estate tax assessor's office. An analyst, possessing aggregate sales and aggregate square footage for a group of establishments, can compute a sales-per-square-foot figure and compare these figures to the proposed development. The City of Virginia Beach, Virginia, has developed sales-per-square-foot benchmarks for several classifications of retail establishments as well as class-A office buildings (which are subject to a gross receipts tax in Virginia). (See Exhibit 1 for a hypothetical example of such a calculation.)
What if these taxes are not imposed locally and, therefore, cannot be used as a source in developing local estimates? Fortunately, relatively inexpensive national sources may serve as local proxies. Several sources are:
* BizMiner (www.bizminer.com) provides national sales per square foot for many classifications of retail for $149. See "Retail Sales Per Square Foot" under "Product Overviews"
* The National Restaurant Association's "Restaurant Industry Operation Report" provides national sales per square foot data for $125.
* The U.S Census Bureau's Economic Census provides state-level sales per square feet for selected establishments for 2002.
* Destination Marketing Association International provides convention-spending data.
* Smith Travel Research produces market trend reports on hotel occupancy and average daily hotel rates for cities for $425.
A Word about Hotel- and Convention-Related Expenditures
For cities with a sizeable convention business, there may be local survey data regarding average daily expenditures by category of expense. In lieu of local estimates, the Destination Marketing Association International has in the past published a survey of expenditures by patrons. An analyst should be cautious in applying local tax rates to survey data. When patrons are surveyed about their expenditures by category, they are prone to cite total expenditures (including applicable taxes and tips). For example, if the survey data indicate the average convention attendee spends $40 per day on meals, that figure includes taxes and tips. Ignoring this issue could result in calculating a tax based on a tax or a non-taxable item. Determining an embedded local tax is easy, since the tax rate is known. Estimating embedded tips is difficult because tipping is discretionary, and some food purchases are not traditionally subject to tips (e.g., fast food restaurants).
It is possible for a proposed development to exceed the prevailing local or national standard. Perhaps the venue quality or competitive advantage is superior to the typical local or national benchmark. A financial analyst should exercise judgment as to whether the difference seems reasonable, or whether the developer's assumption should be adjusted downward for computing the fiscal impact.
The final step is applying the applicable tax rates to the developer-supplied estimate or the analyst-derived or adjusted estimate.
Account for economic displacement effects. Some sales from a new development will likely come at the expense of existing business, which represents the traditional siphoning effect. So rather than assuming a new business will generate a 100 percent net gain to a city, an analyst should seek to estimate the marginal increase (net).
Unfortunately, there does not seem to be any method for determining this effect (some firms may have survey data, but these are proprietary).There are, however, some points to consider. Unique venues such as upscale French restaurants, year-round skiing facilities, or IMAX theaters may lessen the siphoning effect, but because disposable income is limited, spending on a unique venue may reduce the potential for spending at any other venue. For instance, a $75 meal at an upscale restaurant could preclude a round of golf. The new venue could attract patrons from outside the region or a neighboring city, generating new sales at no expense to existing business located within the city, but some venues may discourage visitation (due to overcrowding and insufficient or expensive parking, for instance), or even drive existing businesses out of the community. Further, some venues may capture visits that might have otherwise occurred at a different time and place within the city (referred to as "time switchers," where visitors attend a new venue when it opens, but would have visited the city at a later date anyway).
One caveat should be considered regarding the siphoning effect. As discussed above, economists are trained to think of tradeoffs in purchasing decisions. Using restaurants as an example, when a new establishment opens, some of its sales will come at the expense of other restaurants. But new dining experiences could spur some sales that may otherwise not have occurred. Many consumers do face economic tradeoffs in many spending decisions--if they attend a concert, they may forgo a movie. Some consumers, however, have the financial wherewithal to attend a concert and a movie, and some new dining establishments may lure customers to dine without forgoing a sale elsewhere, raising overall restaurant spending in a city (although consumption of food at home and, consequently, purchases from a grocery store could be forgone).
There are also two occupancy-related displacement phenomena: vacancies and relocation. Whether developed locally or obtained nationally, the sales benchmarks previously discussed are based on 100 percent year-round occupancy, Realistically, new developments may fall short of that threshold (3) and, therefore, will require discounting for vacancies. Another form of displacement pertains to relocations in which some economic activity may represent a transfer from an existing location elsewhere in the city.
Over time, however, as population and income grow, all three effects will diminish.
Consider opportunity costs. A central tenant of economics, opportunity costs, recognizes that resources are finite and tradeoffs exist. Absent annexation and redevelopment, land is a finite resource and subject to opportunity costs. In economic development cases in which two proposals are competing for one site, considering the opportunity cost of one versus the other is an obvious step. But the next best alternative for the site should also be considered, even if that alternative is not immediately present. Speculating about future developments is subject to considerable uncertainty, of course--there may be no practical alternatives, or the site may have remained undeveloped for some time because no businesses had expressed interest.
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