Local Economic Development: Public or Private?

Larkin Building

Usually, when we hear the term "economic development," we think of something that improves the standard of living for our community.

Unfortunately, what economic development often implies to some politicians and pundits is government-guided development whereby public officials pick economic winners and losers by favoring one or more specifically targeted businesses with special favors: tax abatements, subsidies, free land, and other benefits, as opposed to other businesses.

An opportunity cost is the price of the next best alternative foregone. When local agencies use tax money to attract employers and jobs to their community, they often do so with money that must first be taken from someone else.

How do they do it? With the law. There are several major state laws that enable municipal governments to manipulate their regional economy. These laws allow local governments to abate local taxes or create agencies that build infrastructure for commercial purposes and take other steps to increase its region’s economic development, such as increasing area employment or refurbishing of old industrial sites.

Here is a list (by no means exhaustive) of local tools for encouraging "economic development:"

The Economic Development Corporation Act (Public Act 338): This law allows local governments to create an independent economic development corporation (EDC) for purposes of economic development. EDCs can borrow money or issue bonds (or both) for use on various and sundry projects. They can even use revenue generated from a project to retire debts left over from other projects.

Downtown Development Authorities (DDA): State law allows local governments to create Downtown Development Authorities to "construct, rehabilitate, equip, improve, maintain, or operate any building within the downtown for public or private use." They are only allowed, however, in areas that have suffered a significant decline in the number of businesses.

Larkin Parking Ramp

The Midland Economic Development Council is part owner of Larkin Parking Ramp in Downtown Midland. Other cities have private parking facilities.

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Tax Increment Finance Authority Act (TIFA): When property values rise, this law allows local officials to collect a portion of the increase in property taxes, over and above the base year in which TIFA was established. This also applies to DDAs and Local Development Financing Authorities (LDFA). This money can then be used in economic development plans as local officials see fit. The authorizing statute for Tax Increment Finance Authorities has expired, though there are still several in the state remaining in operation.

Local Development Financing Authorities (LDFA): A Local Development Financing Authority is designed for encouraging industrial growth only. The LDFAs are different from the now-defunct TIFAs in that TIFAs were used for much more general purposes.

As of April 28, 1998, there was a grand total of 573 local economic development authorities operating in Michigan. Of these, 351 were Downtown Development Authorities, 87 were Local Development Financing Authorities, and 135 were TIFAs.

One of the most common tools local development authorities use for economic development is the "tax abatement." For example, taxes that otherwise would be involved in starting up a business are reduced to encourage businesses to open or expand in areas government officials would like to see developed.

According to the Citizens Research Council (CRC) of Michigan, at the end of 1993, 6,654 certificates were outstanding for abatement of taxes on new industrial facilities. These certificates represent a tax advantage over their competitors for those businesses receiving them.

Interestingly, CRC noted in a different report that the tax abatement is used most by local governments with the highest taxes. In other words, tax abatements may be necessary to avoid losing businesses to low-tax areas. Of course, other factors may play a role in business development, too. Low-tax areas may also have great schools and low crime rates, which no doubt play an important role in business and location decisions.

Does the tax abatement method meet with success? Not as much as if local officials simply would keep taxes low in the first place. CRC found that greater economic growth takes place in jurisdictions where taxes are low and which consequently grant fewer abatements. CRC found that "50% of high tax jurisdictions experienced low growth, whereas only 18% of the low tax jurisdictions and 19% of the medium jurisdictions experienced low growth." This suggests that keeping the economic playing field level and offering no special favors yields better results than government picking winners and losers through the use of tax abatements.

Poletown is an area of Detroit that once was home to thousands of people on 450 acres, sharing 16 churches, 144 businesses, and one hospital. In 1980, the city of Detroit informed the community that General Motors needed its land for a new Cadillac plant. A war ensued, pitting residents against city government, which was represented mainly by the Detroit Economic Development Corporation. The deal the city put forward–fought by the citizens of Poletown–was to provide $450 million in local, state, and federal subsidies, abatements, and infrastructure improvements in exchange for the land. The residents lost their fight and were forced to abandon their homes when Detroit invoked the state’s eminent domain law.

Nobel Prize-winning economist Milton Friedman is famous for saying, "There is no such thing as a free lunch." What he means is that everything has a cost, even if it is an opportunity cost. An opportunity cost is the price of the next best alternative foregone. When local agencies use tax money to attract employers and jobs to their community, they often do so with money that must first be taken from someone else. The money taken from others is money that otherwise would have been saved or invested and spent according to the priorities of the wage earner. Private action on the part of individuals is what drives the private economy and creates jobs. The net result of government action to "create" jobs, consequently, is that an offsetting number of jobs may be destroyed (or just shifted around) in the private sector.

Regardless of how intelligent or talented local development officers may be, they simply do not have the ability to outguess millions of individual decision-makers in the market. No person or government institution has all the knowledge necessary to understand the impact government actions will have on the vast, interconnected network of interests represented by the marketplace.

The great virtue of people free to act in the market is that each person has a small amount of information to use for his or her own ends. Those ends succeed or fail with each person, without endangering the economic well being of the entire community. But when local development authorities attempt to supplant the knowledge of many economic actors by deciding who should and should not be anointed with tax abatements, low-interest loans, or other government handouts, they attempt the impossible and disrupt a delicate balance. They presume to know something that is unknowable: what is best for each individual economic actor.

Public-sector intervention simply displaces private-sector initiative. It sends private businesses scrambling for the biggest tax abatement they can get, instead of looking for ways to satisfy the desires of their communities and make more consumer-friendly products.

The citizens of Michigan need to understand what politicians really mean when they talk about "economic development." They need to decide whether they really want local officials choosing what ought to be developed, disrupting the local economic balance in the process; or whether private initiative should assume its rightful position as the cornerstone of economic development.