Testimony before Committee on Finance of the New York City Council Real Estate Board of New York

The Real Estate Board of New York (REBNY) is a trade association with 17,000 members, comprised of owners, builders, residential and commercial brokers and managers and other real estate professionals active in New York.  We would like to comment on the Tax Expenditure Evaluation intro.

OVERVIEW

A review of economic development tax expenditures on a regular basis is in principle sound public policy.  However, there are many practical issues that such a review poses that must be considered if the review is to be effective and truly serve its intended purpose.  IBO should be given clear guidance about the program goals and its methodology should be approved by the Council.  IBO should make clear in its analysis the fundamental difference between an economic development program which grants real property tax benefits and other tax benefits, such as sales or corporate tax. 

Also, the public should be involved in this process.  As part of this review, there should be an assessment whether there are significant flaws in the program which impede its effectiveness, especially when programs undergo significant changes such as ICAP. 

OTHER CONSIDERATIONS

Economic development activity--whether it is constructing a new building, renovating an existing structure, or making a leasing decision—is typically a decision made over a period of years.  For an economic development program to be effective in encouraging investment activity, a builder or tenant must be assured as they are considering an investment decision that the program will be available at the time they need to act.  Frequent reviews, which raise the potential of sudden and dramatic changes in an economic development program’s benefits or availability, would undermine its effectiveness.  When reviews are held and programmatic changes proposed, we strongly recommend that these changes should be implemented at least one year after changes are adopted and that such changes include a grandfather provision that enable projects underway to receive the benefits they anticipated the existing program.

For a tax evaluation program to be effective, it is extremely important that there is a clear and complete statement of the program’s goals.  For instance, the Industrial and Commercial Incentive Program (ICIP) the predecessor of the Industrial and Commercial Abatement Program (ICAP) was frequently criticized because it did not create office or industrial jobs but simply moved tenants or businesses from one location to another.  The goal of the program was to encourage capital investment to create new buildings or to upgrade existing underutilized or obsolete space.  This capital investment was going to create construction jobs and indirect economic benefits which were tangible program benefits.  Similarly, it was easy to establish that this investment occurred.  In short, the primary goal of the program and the basis for evaluating its effectiveness should have been capital investment, not on-site job creation.  If this capital investment attracted new tenants to New York then that was an additional economic benefit. At the very least, the tax expenditure evaluation should be clear about what the fundamental goals are (and what they are not) as part of this analysis.

There has been a disproportionate emphasis in discussions about the benefits of economic development programs on whether a project could have proceeded without the benefit.  Another potential goal of an economic development program is not simply making a project economically feasible. Rather it could be to promote economic activity in a geographic area or an industry that advances a clearly stated public purpose.  In such a case, the goal of an economic development program is not simply to make the project feasible but to make the economics so appealing that it makes the economics of one type of project more favorable than another.  One example of this was the 421g benefits in Lower Manhattan which favored the conversion of obsolete office buildings to residential use.

However, economic development programs do not create demand.  The effectiveness of the 421g program was in large part due for the strong demand for housing, non-existent demand for office space in older buildings, and a planning framework to promote mixed use neighborhoods. 

More recently, ICAP analysis presented to REBNY highlighted that hotels and retail projects were receiving the larger share of ICAP special area benefits and that office and industrial uses were receiving a significantly smaller share of those benefits.  This was presented to suggest that the program was promoting the wrong economic development goals, although these goals were never articulated. 

We think this outcome reinforces our point that economic development programs do not create demand.  A better way to assess those results is that there was more market demand for hotels and retail and ICAP benefits made these projects feasible.  In contrast, there was virtually no demand for office and industrial use in these special exemption areas which is why their share of the benefits is lower.  This example raises a key point to consider in establishing goals for the program:  Are the program goal’s unrealistic or hopelessly optimistic.

The methodology and the data are also important aspects of the evaluation.  We attended a Federal Reserve Bank event where analysis of the ICAP program—“Lessons from Evaluating the ICAP”--was presented.  Though interesting, the data and methodology were flawed as a way to assess the program’s effectiveness. 

Here are some of the problems with this analysis.  An inducement study, that only analyzes projects after they are built and operating, ignores the more important period of pre-development.  This period is when success is uncertain, risk is real and the benefits of the program most important.  Before a project is completed, there is the risk of being able to finance the improvements, to complete the construction of the project (either renovating an older building or erecting a new building) and to successfully market the space in the time period projected.  The tax relief that an incentive program provides can mitigate the level of risk and make a project which may be feasible, actually financeable and buildable.  It is at this stage in the development process where the incentive program can advance a public policy goal when two types of development may be equally feasible.

As for the economic data in the study (the income and expense that DOF uses to assess the property), it is an unreliable source for determining a project “hurdle rate” and whether the program induced the project.  First of all, in assessing property, DOF discounts expenses it believes is outside the industry norm (even though this may be an actual expense paid to an independent third party for services rendered).  Next it adds income to a building when vacancies exceed the area average.  This normalization of income and expense may be appropriate when valuing a million properties and for establishing and equitable tax system.  However, using this normalized data to assess profitability and the hurdle rate to evaluate the inducement impact of the program is fundamentally flawed and seriously misleading, especially when there is no evaluation of the inducement value in the pre-development period.

CONCLUSION

We support the establishment of a method of evaluating tax expenditures but we are extremely concerned about the establishment of the goals and the methods of evaluation. 

Also, we would ask that all data used to evaluate a program be made available so that interested third parties can evaluate the results independently.