We meet again, for the very first time.

Another legislative session has begun.  As required by the state's constitution, those elected to serve as senators and representatives gathered last Tuesday to begin the 2013 Legislative Session.  After each election there is a sense of newness and anticipation about how a different set of people will approach the challenge of governance.

There are thirty-three people serving in the legislature for the first time.  While that number seems large, it is not an unusually high number.  Even before term limits, each election saw true freshman making up about one-third of the total.  With term limits in place, it is more common place to see people moving from the House of Representatives to the Senate (four moved from the House to the Senate, with no one moving the other way) and, as a result, a higher number of the freshman class being found in the House of Representatives (28 of the 33).

What will they do?  This will be a most fascinating session.  There are very large issues that are unique and there are the ongoing issues of running a state.  New will be a discussion about the federal government's urging states to increase the eligibility in the Medicaid program and their promise to pay for that expansion.  Governor Daugaard has decided to decline that offer out of a firm belief that it could be harmful to the country and disastrous to the state.  The perennial issues include funding for education in the wake of a defeated sales tax proposal and the process of setting priorities for the resources that are available.

It can be tempting to compare the repeated nature of the budget struggles to blindfolded kids swinging a bat trying to get candy out of a pinata (and seeing the general public as the "at risk" audience).  A gathering of otherwise insightful citizens that have seen others getting clobbered time and again but still they stand there.  It must be that we each assume the victim will be someone else.  So it is with the major permanent issues of each session.  There is the school funding pinata and soon we'll see the blindfolded kids swinging away and someone in the crowd just moments away from complete calamity.

This may be worth a giggle but it's too glib for a larger point.  Issues like school funding, money for law enforcement and prisons, money for highways and bridges, plus working to care for those who cannot care for themselves, are examples of the duties of government that are not episodic and need discussions each year.  Perhaps the most maddening aspect of the "art and science of governance" is the lack of answers that are singularities.  There are rarely issues that have an indisputable "correct" answer.  All the rest are answers that each legislator embraces given their background, values and viewpoints of the world.  it is this diversity that makes this process wondrously aggravating.  The South Dakota Chamber of Commerce and Industry was formed to make sure that the business community was part of this process.  It is our mission and it is our passion.  Let the work begin.


Special Report:  Economic Development - Now What?

Remember that Chinese curse "May you live in interesting times."  As it relates to South Dakota's policies to attract large investments, we have arrived smack in the middle of interesting times.  For 16 years South Dakota has used a refund policy to offset an unusual tax structure that makes us an expensive state for large capital projects.

There are sales and use taxes applied to materials used in the construction of large facilities, including the production equipment (machines and robots) used in the processing and production of products.  In addition to the sales/use tax on materials, there is a 2% tax on the materials already taxed PLUS the labor used to construct the project.

Since 1996, South Dakota has provided refunds as a way of keeping these taxes from driving large investment away from the state.  These refund laws have been amended over the years, with a major revision in 2010.  That revision reduced the number of refund categories from about six levels to two, granted refunds to projects that had costs exceeding $10 million dollars and ended refunds for projects that cost more than $500 million dollars.  This limit did not apply to wind power projects.  This new refund policy was set to expire December 31st, 2012.

New Approach - In 2011, Governor Daugaard proposed a new approach.  Rather than use refunds, this new "Large Project Development Fund" would award grants to provide partial refunds for projects that cost more than $5 million dollars.  Whereas refunds are self-funding (each project pays all of the taxes and part of those funds are sent back to the company as refunds), a grant program needed a source of funding.  The proposal was to take 22% of the Contractor's Excise Tax to put into the fund as an ongoing appropriation.

Under the proposed grant system, the refunds were to be paid as grants.  All of the taxes paid by the project would go directly to the general fund without the need for a liability account to pay refunds.

The new proposal (HB 1230 from the 2011 session) was placed on the ballot using the referendum process and titled Referred Law #14.  It was soundly defeated.  For those interested in the analysis of why the measure was defeated, there are several memos written by the Chamber that can be made available.

Interesting Times - The urgency of the moment.  The law granting refunds for large projects has sunset and is now gone.  The large project development fund (aka RL 14 was defeated on Election Day so it has the same effectiveness as the law that expired).  For the first time in 16 years South Dakota has no policy aimed at encouraging the kind of large investments that create high paying jobs, expand the tax base and make the economy more stable.  There is nothing designed to offset the unusual taxes that make investing large sums of capital here more expensive than in other states.  The competitive advantage is now beyond the South Dakota borders.

What did that election really mean?  Does the defeat of Referred Law 14 mean that South Dakota citizens don't support economic development?  NO!  If there was a mandate in the defeat of RL 14, it should be found in the words of the winners and in conversations from across the state after the election.  The Chamber travels to ten cities before each legislative session to discuss how the business community feels about issues and to listen to people's reactions to election results.  Here are the claims made by the victorious side of the RL 14 vote and comments made by people across South Dakota.

• A belief in economic development - At every debate and in every statement made by the opponents of RL 14 there was a strong statement supporting economic development.
• Support for refunds - The opposition to RL 14 said that they believed the refunds given to wind power were needed and the right thing to do.  This is an affirmation that the tax policy is too expensive for certain kinds of projects and that blunting the impact of those taxes is necessary on occasion.
• Supported refunds for ethanol - Opponents to RL 14 affirmed that the refunds given to the ethanol industry were needed and they expressed support for those refunds.  Readers are reminded that ethanol refunds had their own formula granting 100% refunds for project costs that exceeded $4 million dollars.
• Incentives should be used only where they make a difference in whether the project gets built and where it gets built.
• Funding cannot take funds that have already been placed into the general fund.
• The process should be open.  This was frustrating because the new proposal made the process much more open than the refund policy but was lost in other sound bite battles.

Moving Forward - The next question is what proposals will be made during the 2013 Legislative Session to address the challenge of the state's tax system when applied to large projects.  The Governor has made it clear that his administration is not going to be advancing a set of proposals but rather will be listening to the discussions and watching for common solutions that might emerge from thoughtful debate.  They will be like the kids that gather around a fight on the playground and yell "hit him" just to help things along.

The South Dakota Chamber of Commerce and Industry had a long discussion during the most recent board meeting focusing on the ideas and the basics of a good proposal.  Rather than move directly into specific details, the Chamber offers the following ideas as the philosophical building blocks by which any proposal might be measured.  The Chamber will follow the example of the kids on the other side of the fight, yelling instructions such as "grab his leg" trying to be more helpful, while remaining safe.

On a serious note, the following is designed as a guide to evaluate various proposals and make sure the solutions are addressing the core issues involved in growing the economy of South Dakota.

Affirmation of desired targets and goals.  There should be some discussion and agreement on what types of economic development are the priorities for limited resources.  One rather obvious one is the expansion of local industries that are "primary industries", meaning that their markets are outside the South Dakota economy so they bring dollars into the state.  Manufacturing is the essential center of this type of development and a high priority for the use of incentives.

Another prime example of this type of industry is value-added agriculture.  Wind energy is an industry that has strong political support and a wide range of economic benefits.  Financial services have been the core of growth in recent decades and research is proving to have a promising future that fits the criteria of being a primary industry.

Goals should be as clear as practicable.  These goals can be expressed in the number of well paying jobs or the expansion of the tax base by a certain dollar amount.  There might be value in outlining industries that are part of a cluster which will attract other similar businesses.

Flexibility - After the revisions made to the incentive law during the 2010 Session, one of the most frequent comments heard from the economic development community was the desire for some flexibility in the types of proposals that could qualify for incentives such as refunds.  As a basic principle for the 2013 Session, there should be a discussion about how to express the types of industries desired while allowing refinements for each proposal to account for the needs and opportunities of specific projects and communities.

Simplicity of Administration - Whatever incentives are developed, they must be easier to administer than the refund policies of the past.  It is almost inconceivable to continue a pattern that has featured strong invitations to invest in South Dakota (whether new or for expansion) with special offers and great excitement only to spend years having the Department of Revenue reviewing receipts and haggling about what is a refundable expense and what is not.  To repeat the phrase used during the pre-session presentations, "It is like inviting someone over for Thanksgiving dinner and being all ticked off when they actually show up."

The use of grants was designed to simplify the process.  It is possible to set out an estimate of what the tax will be for a project and set the conditions for receiving a grant.  These grants could then be issued on a schedule that was agreed to by the state and the business making the investment, creating the jobs and paying these and future taxes.

Proven Return - One of the Chamber's most severe frustrations with the annual report of refunds given since 1996 is that it only reports the amount of the refunds.  It completely ignores the amount of taxes paid in total (before refunds) and the amount of taxes that were placed into the general fund even after refunds were paid.  To make this point directly, the Chamber just completed a study of the most recent refund report which shows refunds now total $95,345,148.77 (an accumulative total from 1996).  Here is that number put in context:

• $155,896,976 est. total taxes paid by projects in sales/use & contractors excise (all 49)
• $95,345,148.77 total refunds for all 49 projects
• $60,706,044 est. revenue added to general fund from project construction (all 49)

A new system must be designed to show these returns on the project's initial investment PLUS show the taxes and economic gain as a result of the ongoing operations of the new/expanded businesses.

Openness of Process - In this day and age, the public expects a high level of accountability and of openness with these kinds of processes.  Understanding that no investment will be made if it requires disclosing proprietary information, the process of determining which projects will receive incentives should be as open as possible.  Actually, the process in RL 14 meets these needs well by using the Economic Development Board and following the procedures used when awarding REDI fund loans.  The principle is important, the answer was well-developed and presented.  The rejection of RL 14 was not a judgment of the proposed answer, but rather another baby being tossed with the bathwater.

Conclusion - There will be many proposals for directing the future of economic development over the next few weeks.  Some will address the issue as defined and focus on the impact of the sales/use and contractors excise tax combination.  Other discussions will use these "interesting times" to seek a broader review of all economic development programs and look to redefine the direction of this most important work.

The South Dakota Chamber of Commerce and Industry will be part of these discussions.  The Chamber will be providing analysis to help lawmakers understand the returns needed to keep South Dakota's economy growing and strong.  This work would not be possible without your support.

Thank you for supporting the South Dakota Chamber of Commerce and Industry.