March 2, 2012
What's the matter with incentives? Do incentives matter?
As a matter of fact, they do.
SPECIAL REPORT: Economic Development Policies and the 2012 Session
South Dakota's policies on economic development incentives for those making the largest investments in the state have been the subject of much debate, discussion, diplomacy and a bit of derision.
This article will help Chamber members understand the debates that have taken place during the course of the legislative session regarding incentives and specifically for larger projects. None of this can possibly make sense without some background and even then complete comprehension is elusive.
Background . . . way back, but well-grounded.
This debate has been ongoing for a long time. For 15 years there have been discussions about refunds for ethanol plants and other special projects. It all starts with this, South Dakota has a very reasonable tax structure for businesses, with one exception, the taxes on capital investments needed to build and equip facilities are higher than most other states.
Businesses in South Dakota pay sales/use tax (4% state and 2% local) on construction materials PLUS a contractor's excise tax that adds an additional 2% on the entire contractor's bill, including labor costs, and materials, including the taxes already paid on that material. If you are thinking that this seems like a tax on a tax, you're right. If you're thinking that simply doesn't happen under tax law, you're wrong. Our tax code is rather accomplished at this.
Back to the main point. To offset these higher taxes on projects with very large investments, a program was developed to refund some of those taxes. These refunds have always been considered an investment to assure that projects would be built in South Dakota. In turn, these projects would create jobs and pay taxes to schools, local governments and the state for many years. During the 2010 legislative session, Governor Rounds sponsored a bill to narrow the criteria for refunds and restructured the formula by reducing the levels of refunds from six to two.
During the 2011 legislative session, Governor Daugaard sponsored a drastic change in the approach for large projects. HB 1230 created a fund that could be used to issue grants to offset the higher taxes on capital investment rather than give refunds. Using grants would allow more flexibility, and with that flexibility, the threshold to qualify for these grants was reduced from $10 to $5 million. To provide for public accountability, all grants from the fund need approval from the Economic Development Board, which approves REDI fund loans.
The most significant impact in shifting from a refund policy to a development fund/grant concept is how the program is funded. Refunds have their own source of money. The taxes are paid first and then held in a special account out of which refunds are paid. Then, the balance is placed into the state's general fund. HB 1230 would direct 22% of the collections from the Contractor's Excise Tax to be placed in the fund. This amount was chosen because it is a similar amount of money that is expected to be paid out in refunds so the new proposal would have the same fiscal impact as the previous refund policy.
Democrats Seek and Achieve Repeal - The Democratic Party filed a petition seeking to have HB 1230 placed on the 2012 general election ballot. Claiming that the money should be spent on schools and that incentives are not needed to achieve economic development, the effort was organized to gather signatures. This effort was successful and HB 1230 has been placed on the ballot and will be voted on as "Referred Law #14."
Start of Session - As the 2012 legislative session began, one of the most frequent comments was "Are we going to do something about economic development and keep the refunds/incentives alive?" This was like shouting "Remember the Main!" A comment that may have stirred emotions at one time, but hardly provides solutions and, ironically, is a self-contradiction these days because absolutely no one remembers anything about the Main - it was a ship, wasn't it?
A key question soon developed. What if the legislature could produce a comprehensive economic development policy. What would that entail? Is there a way to address the criticisms of HB 1230 and address other economic development ideas in a comprehensive way?
The answer to this question is tricky because it is both Yes and No. Turns out that it is possible to find a good policy that addresses the issue of dealing with the taxes applied to larger than large projects (think "ultra large") AND find support for improvements to the grant process in HB 1230. What it possible to get past the political and philosophical differences that ended up putting our economic growth policies on the ballot in the first place?
Key Issues - Capitol-ism chooses to stay focused on the policy issues before trying to explain the politics, in part, because the politics of this situation are more than a bit complicated and this newsletter doesn't like to exasperate its readers.
Here is the list of what emerges as key issues regarding economic development policy:
Wind Energy - Wind energy projects in the form of "wind farms" represents an enormous investment that can reach well past $500 million. Wind developers have been worried that the new approach to refunds, meaning the grants found in HB 1230, did not have that same level of certainty as the old policy. There was also a concern that an "ultra large" project, if approved, could deplete the incentive/grant program of HB 1230.
This is a good point to stop and explain that HB 1230 set up the "large project" grant program and the refunds in this new policy are for those projects that are "larger than large" (hence the title "ultra large"), mainly because the pressure is really on - lobbyists just aren't that clever.
The Answer - Return to a refund concept for wind projects. To make the program easier to administer, a formula was designed for the refunds, based on the amount of electricity produced. The policy would be designed to assure the refund was 50% so that the state would never refund more than it collected in this program. Historical note: The refunds used to spur ethanol in South Dakota were 100% of taxes on expenditures over $4.5 million dollars.
Environmental Projects - The three power companies that own the Big Stone Power Plant must build an air system to meet an edict from the EPA. It is a huge project that will cost nearly $500 million dollars. Under the old refund policy, this project would clearly qualify as a large project . . . if this isn't a large project, then one doesn't exist.
The question here is the fact that the project will be built with or without incentives. In this case, the refund will act as a control on rate increases for customers of the power plant. Just like the wind farms, the grants that might address this problem in HB 12130 would soak up nearly an entire year's worth of funds.
- Add this environmental project to the refund policy above, which is designed for the "ultra large" projects and make sure the refund rate does not exceed 50%.
The refunds for the "ultra large" projects will be for projects about $50 million dollars.
Changes to HB 1230 - With the "ultra large" projects set for a refund policy, and with that policy protecting the HB 1230 grant refund from being wiped out all it once, it became possible to address the criticism that the bill was taking money from education and other pubic services.
The Answer - Reduce the amount of Contractors' Excise Tax being taken for the large project grants. The funding for the large project fund could be reduced from 22% of the Contractors' Excise Tax to 18%, which is a 20% reduction and totaled over $3 million.
A provision was added to make sure that the projects qualifying for the "ultra large" refunds would not be able to seed grants from the "large projects".
Repeal and Replace HB 1230 - The final piece of the discussion was a move to repeal HB 1230 and replace it with the lower percent of funds going to large projects and more money for education. In the end, this proved to be extremely politically volatile, was rejected and ended the possibility of a comprehensive solution to these policies. It also assured that the campaign over Referred Law #14/HB 1230 would move forward.
And Now the Politics - Throughout the session, a core of Democratic legislators were interested in this set of policies because they provided a tax break for wind power and returned some funding for education. At the end of the process, the leadership of the Democratic Party didn't think the reduction of funds going to the Large Project Grants was significant enough to meet their concerns. It is fair to note here that several among the leadership of the Democratic Party do not believe that incentives, like tax breaks, are necessary at all and that incentives are especially wasteful when applied to "ultra large" projects. The Chamber politely, vehemently, emphatically and completely disagrees.
Without true bipartisan support, the leadership of the Republican majority and the staff of the Governor's Office were not interested in the combined policies. The bill, known at the time as SB 170 which had passed out of committee amid great flourish - if you like to think of walls of fire and boulders shot at you from catapults as flourish, was tabled on the House floor without debate or hesitation. The vote to table was 65 to 1. It's always a bit mortifying to be on the short end of such an overwhelming vote, but one can take some solace in bringing the House of Representatives together with a unity rarely found during this session.
One of the Chamber's most serious frustrations with HB 1230 being placed on the ballot is the fact that part of the motivation for the Democratic Party was to have an issue that will attract their base of voters.
Final Result - Partial Victory
Having failed to gather support for a comprehensive solution, the business lobbyists set out to establish the policies needed for wind power and the environmental project. Using HB 1228, the refund policies for the "ultra large" projects were passed and are now headed to Governor Daugaard. The first vote on this bill was taken in the Senate and HB 1228 passed with a vote of 18 to 15.
Savvy readers of Capitol-ism will recognize that 18 is the minimum number of votes to pass a bill in the Senate, which has 35 members. On Thursday, the bill passed the House with a bit more comfort and a vote of 52 to 16.
Conclusion - The work to lead a campaign to pass HB 1230 by urging voters to "Vote Yes" on Referred Law #14 is now at hand. If successful, it will result in the integrated policy that had support during the session, with the added element of being approved by voters. If the campaign fails, the state's economic development policies will need to be reestablished and will face the political pressure of having been rejected by voters. That will be a most perilous position.
The South Dakota Chamber of Commerce and Industry will once again be asking members to support a statewide ballot measure to secure the state's reputation as a pro-business state.