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PILOT is broken, and council plan can't fix it

Frederic Sautet, Johnny Shoaf

June 5, 2006

Memphis Commercial Appeal

The Memphis City Council this week may look under the hood of the city's targeted tax incentive policy that aims to lure investment and much-needed jobs.

Amid all the political wrangling, two things are certain about Memphis' Payment-in-Lieu-of-Tax (PILOT) program: It's broken. And the council's proposed solution won't fix it.

The program, which provides tax reductions to select businesses, serves as the area's main tool for attracting companies. Some detractors decry it as "corporate welfare," fearing the city is giving away tax revenue. The City Council is responding with a plan that would have it assume the Industrial Development Board's (IDB) oversight of the PILOT program.

But this merely substitutes Tweedle Dum for Tweedle Dee. The fact is, nobody is capable of determining how much the city is "giving away" or how much the city stands to gain because no one knows which PILOT applicants would have brought their businesses to Memphis without the incentive or how well the companies will do once in Memphis.

The current political debate misses the crucial question in evaluating the 18-year-old PILOT program: Does it produce an economic climate more conducive to growth than other policy options? The economics here is clear: It does not.

Elected officials see the PILOT as a way to invest in jobs. This is what brings the "are we getting enough bang for our buck" mind-set to the forefront. Unfortunately, it's not that simple.

Policy-makers are pursuing the wrong objective. Economic growth creates jobs, not vice versa. Policy should build a climate where growth drives employment. This holds true no matter how many city-sponsored consultant reports rely on crystal-ball-like "multipliers" to try to demonstrate the PILOT's benefits.

Rather than recognizing its role as a facilitator of economic development, the council wants to determine the kind of jobs and companies it recruits, as well as where they locate. Although this plan is no doubt well-intentioned, it's hard to see how it would represent progress for Memphis because the problem is not so much who runs the program, but how the program is run.

In its purest form, the PILOT relies on a core formula to determine which businesses get what breaks and for how long. But from 2001 to 2003, at least 35 percent of the IDB-sanctioned PILOTs were issued for durations that were inconsistent with the IDB's core formula. Now, the City Council is considering the introduction of even more discretion and red tape.

While general tax reductions encourage economic activity, targeted tax incentives may do just the opposite. When policy-makers, elected or appointed, establish a discretionary incentive with the idea that they can direct growth, they stall more significant tax reform. They also harm the entrepreneurs who would have started firms (and created jobs) under a less discretionary system in favor of politically connected companies or those that promise to satisfy political objectives such as job creation.

Previous Tennessee legislatures understood the dangers of allowing localities to selectively assess property tax. They meant to prevent it altogether when they passed an amendment to the state Constitution that banned the discriminatory application of local property tax. State incentive advocates later devised a legal loophole to bypass this prohibition. But the intent of the Constitution is clear. Local politicians should not have the option to play fast and loose with property tax favors.

Some say that Memphis is caught in an arms race with other cities and must offer targeted incentives or risk falling behind. Suggesting that you cannot resist doing something even though its benefits are questionable is disingenuous. Even if other cities are engaging in discretionary tax policy, broader reforms would lure businesses, especially those that other cities' targeted tax policies tend to overlook.

Rather than focusing on who is administering the program, a better solution would be to offer a blanket tax exemption to all new businesses (or at least limit policy-makers' ability to select PILOT companies). Let consumers and the many unemployed Memphians determine if a business is worthy of their dollars and labor. Moderating officials' discretionary power would also reduce politicking and minimize lobbying.

A more politically difficult solution would involve genuine fiscal reform by reining in taxes, debt and public spending. While this would amount to "unilateral disarmament," it would have the best long-term return, as it would vastly improve Memphis' economic appeal.

The more local tax incentives involve officials' discretionary decision-making, the less likely they are to produce the benefits of genuine tax reform. The path to prosperity is guided by a simple prescription: Remove barriers to economic activity, don't try to steer it.

If policymakers improved the business climate by offering across-the-board low taxes, reliable government and quality core services, Memphis would not need government programs to create jobs. Businesses would do it.

Frederic Sautet is a senior research fellow and John Shoaf is a research fellow at the Mercatus Center at George Mason University in Arlington, Va. They recently published a study, "Local Tax Incentives in Action: The Payment-in-Lieu-of-Tax Program in Memphis, Tennessee."