Ending MEGA

A Review of the Findings

Our findings thus lead to the question, Should MEGA be abolished, or should it be reformed?

This study has surveyed MEGA’s evolution during the past 10 years and detailed its track record. As we have seen, MEGA’s original job projections have materialized only in relatively few instances. Even companies that have successfully claimed tax credits under the MEGA program usually fail to create the number of jobs that were advertised in the time frame expected.

Moreover, our detailed econometric analysis of county per-capita personal income, employment and unemployment rate shows that MEGA has had no significant state- or county-level economic impact; indeed, the only measurable impact was often modestly (though not significantly) negative. Our conclusion that MEGA credits did create a temporary shift in employment towards construction jobs is balanced by the findings that MEGA credits had no lasting effect on construction employment and produced no net gain in overall employment. These econometric results are consistent with those of a variety of academic studies of economic development programs like MEGA.

In exploring why MEGA has apparently failed to generate new economic gains, we reviewed a number of possible reasons. First, we examined the uncertain assumptions involved in REMI modeling and the challenges MEGA officials face in determining which firms should receive MEGA credits. Second, we noted that the current economic literature includes at least two broad hypotheses that suggest there are inherent shortcomings of government economic development programs: first, because political and business incentives will tend to overrule good policy; and second, because market economies are too complex for reliable choices about which firms will prove successful.

Our findings thus lead to the question, Should MEGA be abolished, or should it be reformed? Many people will settle this question according to their political philosophy, but we believe the evidence permits an answer that is largely independent of political philosophy or political party.

MEGA, for instance, has been run by Republicans until recently, but similar programs have been overseen by Democrats in Michigan and in other states, and these programs have not enjoyed obvious success, either. Further, state officials have made multiple changes to Michigan’s economic development programs through the years, but these changes have not brought obvious improvements in the programs’ economic impact; indeed, the absence of impact is one reason that officials are moved to make changes in the first place. (For a discussion of the evolution of Michigan’s economic development strategies, see "Appendix E: A Brief History of State Economic Development.") Combined with the review of findings detailed above, it appears that the state of Michigan would be better off eliminating MEGA and concentrating on other policies.

We would add that this conclusion about MEGA is bolstered by several noneconomic considerations. These are spelled out below.

Noneconomic Issues

Constitutional Concerns

In September 2004, the United States 6th Circuit Court of Appeals struck down a state of Ohio economic development program on grounds that it was an unconstitutional restraint of interstate commerce. The decision was rendered in the case Charlotte Cuno, et al. v. DaimlerChyrsler Inc., et al. The plaintiffs included two Michigan residents.

At the heart of the court’s ruling was the U.S. Constitution’s "commerce clause," which vests authority over interstate commerce in the U.S. Congress, not state governments. Ohio had infringed on this congressional power, according to the court, because the state’s economic development program restrained interstate commerce by providing valuable state investment tax credits to corporations that invested in Ohio rather than elsewhere.

This case is widely considered to be a "true test case" of state incentive programs, since the legal challenge was brought primarily against the program’s constitutionality, rather than the particulars of specific decisions made by the program’s officials. Not surprisingly, the state of Ohio appealed the Cuno ruling, which had been made by a three-judge panel, and sought an opinion from the full 12-judge court.

This motion was denied in January 2005. Ohio probably will appeal to the U.S. Supreme Court (the state must decide by mid-April 2005 whether to do so). If the Supreme Court hears the case and upholds the circuit court’s decision, programs like MEGA could all but vanish, since the Ohio program is similar in form to MEGA. As Professor Peter Enrich, one of the Ohio plaintiffs’ attorneys, observes, the MEGA program "is subject to very substantial doubt at this point."[167]

Even if the Supreme Court chooses not to review the case, MEGA tax credit program could be challenged directly by litigants citing the Cuno decision, since Michigan lies in the U.S. 6th Circuit. State officials may soon be forced to evaluate the utility of fighting such a challenge in court, rather than ending the program themselves.

The argument made by the judges in Cuno appears sound. At the margin, the incentives in an economic development program might affect location decisions — they certainly attempt to — and thereby distort interstate investment and trade patterns. Deciding that a firm that locates in Michigan will receive special tax treatment is not significantly different from deciding that the same firm will face a tariff if it locates in Ohio and still tries to do business in Michigan. Such tariffs would clearly be an unconstitutional restraint on interstate trade, so it is difficult to see how a MEGA program passes constitutional muster.

True, some might argue that by the logic above, a "tariff-like barrier" would exist even if Michigan’s tax rates are simply lower across-the-board than those in Ohio. But in a legal sense, the two situations are different. If Michigan lowered its tax rates generally, it would undoubtedly provide an economic incentive for businesses to locate here, but it would in no way discriminate against out-of-state businesses within its own tax code. (Indeed, out-of-state businesses would remain free to locate in states with even lower tax burdens than Michigan’s). The MEGA program, in contrast, distorts Michigan’s tax code in favor of certain in-state firms — and always against out-of-state firms.[168] This attempt to alter the flow of interstate investment violates the purpose of the constitutional bias toward free trade.

Fairness

MEGA’s questionable economic impact and uncertain constitutional status are not the only concerns. A final issue is fairness.

Fairness, admittedly, is not a technical term, and state officials would naturally dispute any suggestion that MEGA’s programs are unfair. Still, given that MEGA does not appear to be meeting its professed goals, the question of its strengths and weaknesses on other measures becomes a legitimate issue in deciding what should be done with the program.

It is unlikely that MEGA comports with the general concept of fairness as it’s understood by most Michigan citizens. When state officials pick "winners" among corporations and other enterprises by offering targeted tax relief, they are implicitly picking "losers," as well — i.e., firms that must pay taxes to support the MEDC, but do not receive MEGA tax credits and must nevertheless compete against firms whose balance sheets are bolstered by such credits.

Consider the situation of the competitors of Lacks Industries Inc. of Grand Rapids. In 1996, Lacks was offered $8.6 million in targeted incentives in the form of MEGA tax credits and other assistance.

As of 1999, for instance, there were 1,395 companies in the state with whom Lacks shared a "Standard Industrial Classification" code, which classifies businesses by industry and economic activity. Businesses within the same SIC code are potential rivals because they often produce similar products or services.[169]

Only six of the 1,395 Michigan companies in Lacks’ SIC code had accepted MEGA deals. Thus, as many as 1,389 Michigan businesses were forced to compete with Lacks without also receiving tax relief from the MEGA program.[170]

The competition between these firms can be intense — as, indeed, Lacks’ 1996 MEGA application shows. The form lists reasons why information about the company should be exempt from public disclosure. Lacks requested this exemption for certain information on grounds that the data would give an "unfair advantage to our competitors."[171]

If it is "unfair" for a firm’s competitors to have information about the firm when the firm doesn’t have the same information about them, it seems at least as unfair for a firm’s competitors to receive tax breaks when the firm doesn’t receive the same tax breaks itself. And since most firms that receive the state’s MEGA grants have rivals not just outside Michigan, but inside Michigan, as well, the state’s sponsorship of MEGA is arguably unfair to many of the state’s own businesses.

Concerns About "Unilateral Disarmament"

As mentioned earlier, a frequent response to public questions about the value of a program like MEGA is to claim that whatever its flaws, ending it would be tantamount to "unilateral disarmament." That is, if other states operate business tax incentive programs, Michigan must do the same, lest it lose economic battles with other states.

But the case is not so clear cut. As Peter Fisher noted when asked by The Detroit News about ending MEGA, "Of course you can unilaterally disarm when you’re talking about an incentive — like the MEGA tax credit — that isn’t very effective anyway."[172]

Thus, ending MEGA and adopting a more effective policy is not unilateral disarmament; it is true armament. Ending MEGA could allow state officials to focus more clearly on broad-based reforms that have a better track record.

After all, every MEGA award is an implicit admission by the state that for that particular firm, it costs too much to do business in Michigan. If this fact is true for a particular business, it is probably true for many of its competitors.

There are 105,000[173] Michigan businesses with Single Business Tax liability. Through December 2004, fewer than 230 of them have enjoyed tax relief through this program. It would not strain economic theory to suggest that these 105,000 businesses would have created as many — if not more — jobs as the MEGA program’s 230 deals if state officials had just cut the Single Business Tax for all of them, instead of targeting tax relief to a handful of enterprises.

Ultimately, the concern over "unilateral disarmament" may become moot. Given the constitutional problems with economic development programs like MEGA, all states may be forced to renounce them. If universal disarmament is coming, Michigan might receive a "peace dividend" by becoming the first to set out on a new path.

Alternative Measures

States do have alternatives to conventional economic development programs. The economic research literature suggests there are other government policies that are more likely to improve a state’s economic growth.

One area of government policy that could produce economic benefits is tax reform, such as lower tax rates, more equitable tax treatment or simplification of the tax code. Michael Wasylenko, for one, has noted the potential problems caused by a policy focus on targeted (or "ad hoc") tax incentive programs, rather than systemic tax reform:

Most important, ad hoc tax reforms should not be used as a back-door remedy to systematic deficiencies in a tax or fiscal system or in the name of improving the business climate. A band-aid approach to tax reform creates more inequities and inefficiencies than it resolves. When the business climate of a state becomes so problematic that tax laws need to be changed routinely to attract businesses, the practice may be a symptom of problems with the tax system itself and a signal that systematic tax reform might be a more useful approach. In effect, tax reform treats existing and new firms equally, and responsible reform will also systematically account for any tax revenue lost due to reform. It is probably the case that sound tax and fiscal policy obviates many of the tax perks that businesses seek.[174]

Lower tax rates in particular could make Michigan’s business climate more competitive. Michigan’s state and local tax burden as a percentage of personal income exceeds the national average, and its corporate tax burden has been called the worst in the nation by the Tax Foundation of Washington, D.C.[175] And lowering taxes might well affect more than business location decisions. For example, economists Robert Genetski and John Skorburg found that an increase in a state’s tax "effort" — a sophisticated measure of tax burden — led to a corresponding decrease in a state’s personal income growth compared to the national average.[176]

There are also signs that the state’s regulatory system is beginning to stifle growth, particularly in areas of telecommunications and environmental regulation.[177] And insofar as government services are a key amenity, Michigan’s public education system continues to generate escalating costs with no corresponding increase in educational quality.[178]

MEGA analyses also frequently cite Michigan’s above-average labor costs. In one such analysis, MEGA officials note that stating that a portion of a company’s "cost differential is attributable to wage rates in (another state) averaging 7 percent lower than in Michigan for the same job classifications."[179] Lower labor costs could take the form of a right-to-work law, which would allow workers to be employed at a unionized firm without joining the union or paying dues to it if they chose not to. One 2002 study found that, from 1970 through 2000, manufacturing employment in right-to-work states has grown at an annual average of 1.7 percent faster than non right-to-work states during the same period.[180]

Possible Reforms to MEGA

As we noted above, we are skeptical that reforming MEGA will significantly improve the program’s economic impact. The problems we listed earlier under "MEGA: Explanations" seem likely to undermine attempts to correct the program’s current shortcomings. Our first proposal for reform therefore remains what we suggested above: ending MEGA and pursuing basic reforms to the general policies that shape Michigan’s economic environment.

If policy-makers are unwilling to end the program, we can offer other recommendations for reform that may improve the program’s performance in some ways, though the improvements are not likely to create a meaningful increase the program’s overall economic impact.

Audit MEGA

As we noted earlier, past audits of the state’s economic development programs by Michigan’s Office of the State Auditor General have revealed shortcomings in the programs’ claims of success. In one instance, an audit uncovered that in a report to the Legislature, the Michigan Strategic Fund overstated job claims for two programs by using "company projections rather than actual jobs created."[181] In another instance, the agency failed to investigate closely the jobs creation numbers submitted to it by business grantees.[182]

The state could consider conducting regular, expanded audits of MEGA’s direct job counts. Such oversight might not only clarify the success and failure the authority has achieved, but could encourage more efficient accounting procedures at the authority.

The auditor general’s office could also be encouraged specifically to review applications by MEGA candidates that were rejected. A review of these applications might help determine how many MEGA applicants chose to move to, or expand in, Michigan despite being rejected for MEGA incentives. The results of such a review could help clarify the extent to which MEGA agreements are indeed ensuring that the tax credit is necessary to a firm’s decision to locate in Michigan. The review could also lead to improved procedures for determining which companies should receive the credits.[183]

Count Direct Jobs Only

As we noted earlier, we faced a number of difficulties in determining the basis for the indirect job claims made by MEGA officials (see also "Appendix B: Information Requests to MEDC"). These difficulties suggest how much harder it is to assess the program’s impact when the creation or retention of "indirect jobs" is held to be an important measure of MEGA’s success.

Even if the numbers were transparent and immediately available, they would still be based on assumptions that can prove faulty in retrospect (for instance, see "Failed Employment and Wage Assumptions" in "Technical Considerations in the Modeling Used by MEGA"). Indeed, professional economists of goodwill can quickly disagree over computations of indirect job effects. And ultimately, indirect jobs, unlike direct jobs, are inherently difficult to identify and count, making it harder to challenge nonprofessional estimates of dubious quality (see the discussion of MEGA’s claim of creating 28,812 total jobs in "MEGA Job and Project Performance," under "MEGA's Track Record").

It would probably facilitate public review and understanding of the program if indirect job benefits were no longer reported and cited by MEGA officials. "Spin-off" considerations could still be part of the evaluation process for a particular project, so that a project that promises greater spin-off benefits is more likely to be chosen, but MEGA would no longer make a formal or informal practice of tallying the indirect jobs its past and future projects could claim. Removing MEGA officials’ focus on indirect job counts might free the authority to more carefully document its direct job creation — the issue we addressed in "Audit MEGA," immediately above.

Develop Transparent and Timely Reports

The status of each MEGA project could be posted and updated live on the Web each month to show the following:

  • the state and local incentives offered in each MEGA package;

  • the state and local incentives claimed in each MEGA package;

  • the cost of these incentives so far and in the current year;

  • the current direct job figures;

  • what the direct job figures were originally projected to be at present;

  • what the direct job figures were initially projected to be at the end of the tax abatement period;

  • what the direct job figures are currently projected to be at the end of the tax abatement period;

  • a brief and simple assessment of the project’s status based on these figures, such as "currently below targets, but projected to reach them by 2007," or "currently meeting targets but unlikely to maintain them in 2006";

  • an annual summary of MEGA’s success rate in meeting its targets based on the data above.

Ultimately, MEGA cannot be effective if its program reports are not clear, analytical and open to public scrutiny. Quality improvements at MEGA will be much easier to achieve if a thorough and accessible track record is available to MEGA officials and to the elected officials who evaluate the program’s effectiveness.

Commission an Independent Econometric Review

An independent researcher could be engaged to maintain a peer-reviewed and publicly transparent econometric model that annually reassessed MEGA’s impact. The model we employed in this study[184] is crafted to detect past impact, rather than predict future performance. Regular updates of the findings would therefore be appropriate if MEGA continues.

A number of qualified university academics could undertake such research. The University of Michigan’s world-renowned Office of Tax Policy Research would be eminently qualified to perform such an evaluation. If it were deemed more appropriate to find researchers outside the University of Michigan, Syracuse University, Harvard University and the University of Tennessee all operate top-notch programs with which the state might contract for an econometric evaluation of the MEGA program.