State, provincial and local governments utilizing incentives defined by an economic development policy do so to promote, grow (or maintain) the local economy through job creation, wage and compensation growth, and/or tax base expansion. However, jurisdictions utilizing economic development incentives have very different objectives from the businesses receiving them. Public bodies are responsible for providing services to citizens while businesses, which in many cases have come to rely on incentives and subsidies, are focused on maximizing profits.
Many entities clearly define performance criteria and outcomes for development (or re-development) projects to achieve, and then make the incentives contingent upon achievement of those outcomes. Ideally, payment of the incentive or subsidy is then provided at the point of achievement.
This is not always feasible as some projects require significant upfront investments. For these projects, clawback provisions can be used to protect the governments portion of the upfront investment. If the outcome is not reached in the specified timeframe, clawback provisions in development agreements call for the private entity to return all or a portion of the incentive related to established goals, or perform other remedies to lessen the impact on the government and protect the governments investment in those incentives.
This best practice will give the finance officer guidance on how to structure performance criteria and clawbacks to mitigate risk.
The Government Finance Officers Association (GFOA) recommends that any jurisdiction's economic development incentives have specific goals and criteria that serve to define the economic benefit that both the government and the entities receiving the incentives expect to gain from the incentives, the conditions under which the incentives are to be granted, and the actions to be taken should the actual benefits or outcomes differ from plan.
Definition of Goals
Typical goals related to development or re-development projects should focus on the direct benefit to governments from the development. Examples may include revenue generation, net budget impact, number of jobs and average annual income per job created over a period of time, increases in sales tax revenue, amount of capital investment, amount of land developed to productive use, etc. Other goals established can also include the placement of headquarters at a specific site, production values, and technological improvements.
Development of Performance Measures
Monitoring performance in connection with these developments is essential. All goals should have clearly defined performance metrics that are either quantitative or include an objective assessment that can determine if the goal is met. Common metrics would include jobs created, increase in assessed value, revenue generated, etc. With every measure, it is important to very clearly define the measure and how source data will be collected. In defining specific measures, governments will want to determine what metric is the best indicator of goal achievement. Often, this may involve multiple measures or an overall index of multiple measures.
With many projects, the finance officer needs to consider any cannibalization of current revenue sources, such as sales tax, from similar, directly or indirectly impacted businesses and measure this impact as well. Measures should be developed to ensure that achievement of the measure does not create adverse incentives for the developer (e.g: cannibalization of existing development to make a project successful, but results in no net gain for the community).
Collecting and Reviewing Performance Data
Governments should then either rely on its own data collection efforts or utilize a third-party source of data. Data reported from the developer should only be used if appropriate validation efforts are taken.
Finally, where possible and practical, GFOA recommends a collaborative review of performance measurement data from a broad base of departments. This can help produce a higher degree of objectivity during the data review process. Alternatively, some jurisdictions might consider segregating review duties across several departments and then comparing the review results to achieve the same effect.
Use of Clawbacks
For projects where investment is required upfront, clawbacks are used to mitigate the development risk of the project. The triggers related to the application of clawbacks are typically tied to the measurement of the success or failure in the achievement of the development goals.
To ensure a common understanding between the government and the developer of the development goals, metrics, and source data, it is recommended that these items and related clawback provisions be established within a written agreement, developers agreement or performance agreement. When developing clawbacks, governments need to consider:
- the expected benefits of the project
- the timing of benefits against progress towards goals
- the measurement of those outcomes against goals established
- when the clawback provision will be implemented
- hard-lined versus flexible clawbacks
- conditions considered for renegotiations
- considerations for modification of goals.
Preparing A Local Fiscal Benefit-Cost Analysis, International City/County Management Association (ICMA) Report, Volume 37, Number 3, 2005.
Fiscal Impact Analysis: How to Use It and What to Look Out For, Government Finance Review, GFOA, October 2007.
A Financial Analysts Toolkit: Analyzing the Fiscal Impacts of Economic Development Projects, Government Finance Review, GFOA, June 2008.
GFOA Best Practice, Developing an Economic Development Incentive Policy, 2008.
GFOA Best Practice, Monitoring Economic Development Performance, 2009.
Paul Harris and Ronald Berkebile, A Financial Analysts Toolkit: Analyzing the Fiscal Impacts of Economic Development Projects, Government Finance Review, June 2008.