THE SHADOW WAR BEGINS: THE IDB DEBATE
In this BAWI and selling of the South context one of the most important disruptions in American economic development history develops: the tax-exempt industrial development/revenue bond. Today the IDB is a common, well-thought-of ED tool. It had, however, a very rough start. The IDB originated in the South and quickly became perceived as the cutting edge of a southern strategy for pirating northern “branch” manufacturing firms. The North (the Policy World and the public finance world also) reacted negatively, very negatively. The resulting several decade-long conflab is a “shadow war” for the Second War Between the States that erupted mid-1970s.
The Initial IDB Diffusion
BAWI was a time bomb, impacting decades after it was first introduced. Interrupted by World War II, postwar use of BAWI IDBs got off to a slow start in the late 1940s, growing incrementally during the fifties and flourishing in the sixties—culminating in 1968 federal legislation. The BAWI IDB rubbed raw exposed nerves caused by shifting tectonic plates of our Markusen profit cycle. An aggressive southern state attraction strategy meant the IDB innovation was a threat to northern economic bases. In reaction, many northern (and western states) adopted their form of IDB, less to attract southern industry than to offer a business-retention tool to their firms. Whether the IDB served as an attraction or retention strategy, the program offered a manufacturing firm municipal tax-exempt financing to construct and equip a manufacturing facility (Stinson, 1967, p. 6). There are several ways this could be accomplished, and “IDB-like” alternatives were developed. Firms sensitive to price competition and in need of lower-cost labor thought IDBs interesting—and the IDB from the early 1950s on became a matter of great importance to northern state and local officials.
By 1949 only three neighboring states had authorized a BAWI-like IDB: Mississippi (reauthorized 1943), Kentucky (1948) and Alabama (1949) (ACIR, 1963). BAWI IDB pioneers were cotton belt, boll weevil, Great Migration exodus states in the East South Central census division. Illinois and Tennessee approved IDBs in 1951, and Louisiana in 1953.These East Central states were neighbors, Illinois their target. The postwar BAWI IDB entailed municipal revenue bond and/or general obligation (GO) bond issuance. (General obligation bonds were secured by taxes, revenue bonds by private project revenues only.)
Between 1955 and 1957 New Mexico, Colorado, North Dakota, Vermont, Washington and Wisconsin joined the parade; in 1958-60 Arkansas, Georgia, Maryland and Missouri authorized IDBs. Between 1961 and 1965 other states joined in: Kansas, Nebraska, Oklahoma and Minnesota (1961); Maine and Virginia (1962); Iowa, Michigan, Arizona, West Virginia, Wyoming (1963); Hawaii and South Dakota (1964); Montana and Rhode Island (1965) and Oregon in 1966. Total IDBs issued between 1953 and 1962 were less than 1 percent of total municipal bond issuance (ACIR, 1963). BAWI IDBs were not flooding the municipal financial system. The ACIR report stated that cumulative IDB issuance through 1950-62 totaled only $461 million nationally. Moreover, only a few states were intensely using the financing tool.
Twelve states issued at least one IDB between 1950 and 1965; but $392+ million (85 percent of the national totals) were issued by Tennessee, Mississippi, Alabama and Kentucky—the four East South Central states—plus their neighbor, Arkansas. Non-southern states issued only $33.4 million (7 percent); Washington issued 0.5 percent, restricting IDB issuance to port authorities only. The only states that issued at least one BAWI IDB in this period were Mississippi, Tennessee, Alabama, Kentucky, Arkansas, Missouri, Oklahoma, Kansas, Nebraska, New Mexico, Washington and North Dakota. Twenty states authorized IDBs and didn’t use the tool at all during this period. Illinois, for instance, authorized IDBs in 1951, but 12 years later had not issued even one. Wisconsin approved IDB legislation in 1957 and by 1963 had issued no IDBs; Alaska, Vermont and Colorado also had not issued any IDBs. Virginia, Maine and Minnesota did not issue IDBs until a considerable time after formal authorization. In short:
- Some states did not adopt the IDB at all.
- The intensity/volume of IDB use by a state after adoption varies considerably.
- The tool “mutates” due to political culture/state constitutional differences and different needs and time periods.
- States behave like a herd, so each will have the “arrow in their quiver,” which guarantees that it is available to defend the state, if necessary. It may or may not be a meaningful element in the state/municipal ED strategy, but it’s there if needed.
Post-BAWI IDBs were not similar. There were several varieties. The IDB disease had spread, but it had mutated as well. Many states caught the IDB disease, but did not get sick. Diffusion is only part of our story. The East South Central IDB “model”, the most virulent, was not the model adopted by the rest of the nation. Post-1950s’ IDB diffusion is yet another example of our awkward saying that “a rose is not necessarily identical to another rose”. An IDB adopted by one state is likely to be significantly different from an IDB adopted by another state. Variability of tool diffusion exposes the importance of states with their distinctive state/municipal politics, policy processes and political/legal culture.
The core problem is definitional—just what constitutes an IBD? Does an IDB necessarily have to follow the BAWI model? Massachusetts, for example, did not use an IDB in this period because the loans it made were not federally tax exempt. Massachusetts created its own version of an IDB, using state loans to conform to its constitutional gift and loan provisions. Massachusetts is not included in the above listing (neither is Pennsylvania). At that time, these states—Massachusetts the most active—had approved 407 loans ($33 million) and disbursed 292 loans ($20 million). In 1958 the Committee for Economic Development (CED) conducted a national survey on IDBs—totally ignoring the Mississippi and Pennsylvania models (because they were not accepted in “certain quarters”). The CED asserted that Maine (1949), New Hampshire (1951), Massachusetts, Connecticut and Rhode Island (1953), North Carolina and New York (1955) and New Jersey (1958) had at least authorized IDBs. Except for Maine, none were included in ACIR’s BAWI-based report. These states had devised non-BAWI models for IDB issuance. The BAWI model used general obligation bonds exclusively (postwar versions also permitted revenue bonds). Non-southern states overwhelmingly issued revenue bonds only—not following the East Central States and Louisiana, which chiefly used tax-backed general obligation bonds.6 Whether the taxpayer or the company has ultimate recourse for debt issuance is not a small matter.
A Rose is Not a Rose: State IDB Models
So, IDB diffusion resulted in several variants or models. Using a framework developed by Robert J. Tilden (1966, p. 9ff.) we summarize five pre-1968 IDB models.
+ Mississippi-BAWI model: (1) financed by government obligation and revenue bonds; (2) authorized municipal level jurisdictions (later counties) only; (3) state established standards and approval procedures (including certifying municipal eligibility, requiring referendum and certifying legislative compliance); (4) linked to tax abatements, facility construction and private ownership; and (5) includes federal income tax exemption (Mississippi, 1936).
+ Kentucky Plan: (1) financed by revenue bonds only; (2) state and sub-state governments can issue IDB; (3) formation of a jurisdictional EDO specifically empowered and configured to issues bonds; (4) shares with BAWI linkage with tax abatement, facility construction and federal tax exemption (Kentucky, 1948); most common (15 states including Vermont and Maine, 1962).
+ Pennsylvania Plan: (1) financed not by bonds but by state appropriation; (2) state control thru specialized state EDO, Pennsylvania Industrial Development Authority (PIDA); (3) requires sub-state jurisdictions to form specialized EDO which secures private first mortgage for a facility, supplemented by a 30 percent loan/second mortgage from PIDA and 20 percent sale of notes to private investors; (4) no federal income tax exemption—no bond issued, but usually linked to tax abatement and facility construction (Pennsylvania, 1954).
+ Oklahoma Plan: (1) financed by general obligation and revenue bonds; (2) state authority with power to make second mortgage loans (like Pennsylvania) to local EDOs whose financing is based on issuing general obligation bonds; (3) linked to tax abatements, facility construction and ownership, and includes federal income tax exemption. (Oklahoma, 1959), New York, Maryland and New Hampshire.
+ New England Plan: (variant of Pennsylvania) (1) attaches state guarantee to loans/mortgages made by specialized municipal-level EDOs; (2) to build, lease or sell industrial property to private parties; (3) state guarantee (90 percent) of such loans pledging credit of the state; (4) pioneered by Maine,7 later referred to as the Development Capital Corporation model (DCC) (Maine, 1965, Rhode Island, Vermont and Massachusetts).
The Pennsylvania model provides a fascinating case study as to how a state model developed. The Pennsylvania alternative evolved from the 1945 Scranton Plan. Scranton responded not to BAWI-fostered competition, but to post-World War II collapse of Scranton’s economic base. At war’s end Scranton’s economy imploded. While losing textile mills to BAWI IDB attraction was an issue, the anthracite coal industry collapse was the real catastrophe that threatened to make Scranton and northeast Pennsylvania into ghost towns. Under chamber leadership, with support of the city’s leaders, a network of EDOs was created (at least four handled aspects of the plan).8 Raising funds from citizens and the private sector, Scranton-area communities funded mortgages to acquire vacant properties which would be marketed by EDOs to firms outside the area. At the end of the lease the relocated firm would acquire the facility. This is the Scranton version of the BAWI program.
The Scranton Plan intended that relocated firms pay low rents, hire workers and create disposable income within the region. Some would say this is nothing but a BAWI “buy a payroll” endeavor, and they would be correct. After an initial firm was attracted to Scranton, the public–private partnership followed up with cookie-cutter, community fundraising injection of municipal capital to acquire new properties, build industrial parks, etc. After five years in operation (1950) 15 firms had been recruited, a number of business parks planned and built, and 16 additional firms had been also relocated without Scranton Plan involvement. Unlike the hated (and southern) BAWI, the Scranton Plan became a model for the state to emulate.
The Pennsylvania Plan improved the Scranton Plan. Approved in 1955–56, it created a state finance agency, the Pennsylvania Industrial Development Agency (PIDA), to financially participate in issuances of local development corporations. Local EDOs were specifically empowered by state legislation throughout the state. Under the Pennsylvania model, PIDA would make loans to local quasi-EDOs for (initially) 30 percent of construction costs for industrial plants and parks. The state IDC loan obtained a second mortgage as security. The remainder of the funds needed to complete the deal were raised by the community and firms involved. Tax abatement was not automatic and there was no authorization for a municipal IDB, either revenue or general obligation. PIDA received its funds through state appropriation. The role of PIDA, supplying 30 percent (later 40 percent), of the financing was critical. By 1967 the Pennsylvania model had been in operation for ten years; over $104 million had been loaned by PIDA to the LDCs; and nearly 84,000 workers, it was claimed, had been hired (Stinson, 1967, p. 9).
The Pushback against IDBs
There were several criticisms and concerns associated with the IDB. In effect, the IDB/IRB allowed a municipality to issue debt (with a lower municipal bond interest rate) on behalf of a private firm. Given state constitutions usually contain a “gifts prohibition”— i.e. the municipality cannot issue debt for private gain—the IDB could be viewed as a targeted loophole, a business climate opportunity, or a damnable abuse. The IDB inherently and intentionally blurs the public–private distinction. The IDB/IRB is a state-authorized debt instrument whose interest is exempt from federal income tax. The unintended federal income tax exemption on behalf of one state’s private firm which “cost” is shared by all states, including the state that may have had its firm “stolen”. Also, municipalities not wishing to issue IDBs might be compelled to counter the IDB advantages, and a 1950s’ fear that financial market distortions might result (they did not). Finally, IDBs might benefit companies who did not “need” the IDB incentives.
Though cumulative volume of IDB bond issuance was remarkably small and, in the grand scheme of things, relatively few firms used IDBs, northern (especially) and midwestern politicians were upset. They couldn’t stop southern state promotional activities or kick out southern governors visiting their industries. Northern state and local officials feared they would be drawn into a “race to the bottom” by cutting the wages and benefits (and taxes) in their economic base. So the “empire” struck back. Since the IDB ultimately rested upon the federal income tax exemption— disproportionately paid by northern/midwestern residents—it was patently unfair that southern states/communities garnered the benefits paid for by others.
As the IDB diffused across the nation during the fifties and sixties, it generated an ever-increasing dialogue from media, politicians and academics. In late 1962 the matter was referred to a federal research institute, the Advisory Commission on Intergovernmental Relations (ACIR), for investigation and comment.9 ACIR’s 1963 report and 1965 amendment (from which we have drawn much of our statistics and detail information) took a position against the IDB (to which Senator Muskie dissented). The report concurred that rage and IDB abuse were overstated and media driven—the numbers were just too small to account for any material change in the employment base of any city or state. Instead of impassable federal legislation, ACIR suggested a number of reforms that states and localities could adopt. The report focused on future reform efforts which culminated in federal legislation first in 1968, and later in the Reagan years.
The report asserted that there were logical reasons to employ the IDB, chiefly limited to access to financial markets for small rural communities. The problem was that other states and communities perceived the need to defend themselves. ACIR investigated the issue of “runaway plants”. It rejected the concern for runaway firms, asserting that firms moving across regions were doing so for cost and market advantages, and that tax incentives played a very minor role in any firm’s location decision:
Local industrial development bonds are alleged to appeal to the runaway and the footloose industry. Evidence does not support this in any substantial way. Runaway industries, like airplane accidents, occur relatively infrequently but make good copy. We have not been able to identify more than twenty firms that have moved lock, stock and barrel from the North or East into the industrial bond financed (i.e. BAWI model states) buildings in the South. (Stinson, 1967, pp. 70–71)
In 1968 the North struck back in the form of congressional legislation reforming IDBs. More and more research during the early and mid-sixties asserted the IDB was an incentive whose chief benefit was provided by the federal government through firm-avoided income taxes (Crepas and Stevenson, 1968, pp. 105–9). Many a grim confrontation occurred in Congress alleging abuse and demanding regulation reform (Senator John Kennedy was active in the fight). Unions also were heavily involved. So in 1968 Congress enacted the Revenue and Expenditure Control Act, which limited tax exemption to industrial development bond issues under $1 million. The legislation created two classes of IDB: exempt and small issue. Small issue, more useful to economic developers in attracting and retaining firms, lost much of their attractiveness to firms. Issuance of small issue IDBs plummeted after 1968 and did not significantly change until 1978 Congressional legislation undid some of the exemption limitations.
Ron W. Coan 