Tax Incentives: Come On-A My House

Despite hard times in the technology sector, state agencies still offer candy to high-tech employers.

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These days, bankers trying to peddle technology IPOs are about as well received as Dr. Atkins at a “Meat Is Murder” rally. In the first six months of the year, only 9 tech stocks went public. For the same period the year before, that number was 172, according to ipo.com.

It’s hard to blame institutional investors for shying off the tech sector. The fall from grace of technology companies, while well documented, remains mind-bending. In the first six months of 2001, stocks in the tech-heavy Nasdaq lost more than 60 percent of their value. Right now mange would be an easier sell for Wall Street.

This is not to say that everybody has stopped investing in technology. Indeed, a recently released survey shows that while portfolio managers may be swearing off high-tech companies, economic development agencies most definitely are not. In fact, in the poll of 113 state and local development authorities, conducted by professional services firm KPMG (www.us.kpmg.com), a surprising 97 percent of state respondents said they are making it a high priority to attract high-tech and ecommerce companies this year (see the chart at the end of this story).

The campaigns go beyond lip service. Almost 80 percent of the state officials in the poll — and over half of the local authorities — reported that they have recently sweetened their incentive packages to lure high-tech businesses. The preferred sweetener: an investment tax credit for capital outlays. “For example, a company may get a 1 percent credit for everything they spend in a particular state,” says Kerstin Nemec, national partner in charge of KPMG’s strategic relocation and expansion services practice. Many states also offer sales and property tax exemptions for high-tech relocators.

The reason for all of this largesse is not hard to fathom. Like professional sports franchises, high-tech companies confer major league status upon a locale. And landing a handful of tech companies makes it that much easier for politicians to promote a state as a cutting-edge, 21st-century domicile. Gov. Jim Gilmore of Virginia dubbed his state, which aggressively courts high-tech relocators, the “Digital Dominion.”

Such campaigns play well with the voters. So, too, do high-paying jobs. Despite their recent spate of subpar earnings, technology employers still pay above-average salaries — and thus generate above- average tax revenues. What’s more, high-tech manufacturers tend to be nonpolluters, which is a big plus in this age of environmental lawsuits. Moreover, technology companies often serve as anchor tenants in programs to spur commercial development in a particular region. “If a city or state can get known as a hub for high tech,” says Nemec, “it may attract even more business — similar to what San Jose did with Silicon Valley.”

And as some observers have pointed out, the technology sector may be enduring rough times, but nevertheless it continues to attract private capital — particularly from venture capitalists and corporate investors. “There still is activity out there, and state and local agencies are trying to grab as much of that as possible,” says one industry-watcher. “Just because the economy is slowing doesn’t mean high tech will go away.”

Tech Wars

But it might move away — for the right price. This past spring, for example, executives at Boeing announced that they intended to move their corporate offices out of Seattle — the company’s home since 1916. After months of deliberation, managers at the airline and aerospace manufacturer narrowed down the choices for their new home to three possible locations: Chicago, Dallas — Fort Worth, and Denver.

While representatives from all three cities offered incentives to Boeing, the company was ultimately swayed by Illinois’s existing Economic Development Through a Growing Economy (EDGE) program (www.com merce.state.il.us/communities/edge/edge.htm), which intends to make the state as business-friendly as other states that impose little or no corporate income tax. To be eligible, a business must have annual revenues of at least $25 billion and must relocate at least 250 employees. Under the EDGE program, Boeing reportedly got a package valued at nearly $64 million over 20 years — $41 million of which will come from tax incentives, relocation assistance, job training, and development grants. Boeing began operating in its new headquarters in Chicago in September.

Obviously, local governments that have ample treasuries can offer ample incentives. Governments with limited capital resources have a harder time attracting — and retaining — high-tech businesses. Take Arkansas. While the Diamond State has its fair share of high-tech start- ups, keeping them put has proved difficult. “Companies that started here have had to go outside the state for venture capital money to expand,” notes Gene Eagle, vice president of development finance for the Arkansas Development Finance Authority (www.state.ar.us/adfa/index .html). “Then the VCs want them to move out of state.”

To keep local companies local, the Arkansas state legislature recently OK’d the creation of a special economic development fund. Based on a model first established in Oklahoma in 1993, the fund targets not only high-tech companies but also investors in high-tech companies. “We want to have that investment talent here,” says Eagle. “Not just the money, but the people who know the industry and know how to do the deals and structure them.”

To that end, Arkansas officials are offering potential capital contributors a rarity in the investment world: a sure thing. Institutional investors and VCs that plow cash into the fund — in the form of loans — will be guaranteed a specified rate of return on their investments. If the actual returns on those investments fall below the agreed-upon rate, the state will provide tax credits to make up the difference.

Although the coupon for the loans has not yet been negotiated, officials in the state believe they will be able to raise around $80 million for the fund. The fund’s managers will be free to invest in any industry, but, as Eagle points out, the bulk of the money will likely go to high-tech companies. “Those are the jobs of the future,” he explains.

While some critics have questioned whether the state should be playing favorites among industries, officials at the Development Finance Authority defend the plan. The guaranteed payoff, says Eagle, will help level the investment playing field by diverting cash from more traditional VC stomping grounds — places like California, Massachusetts, and New York. “Arkansas is lagging behind the US in terms of the level of growth and jobs,” explains Eagle. “To bring us forward and to catch up, we’ve got to change the way we try to attract and grow our companies.”

Lovers Out, Nerds In

Other officials may also give the brush-off to the invisible hand of capitalism. Legislators in Arizona, Idaho, and North Carolina are considering using tax credits to guarantee returns for investors in high-tech businesses.

Raleigh, North Carolina’s interest in such a plan is not surprising. According to KPMG’s Nemec, southeastern states lead the US in the use of tax incentives to attract or retain companies. The state of Virginia, for example, which used to be for lovers, is now apparently for techies. Last year the state amended the Virginia Investment Partnership Act of 1999, a program providing grants to manufacturers in the state that expand their facilities. Under the amended act, grants can go to nonmanufacturers — read ecommerce operators — that invest $100 million in the state and create 1,000 new jobs.

The plan works like this: State development officials conduct an ROI analysis with companies that have invested a minimum of $25 million in an existing facility. If a company invests more than enough over a 5- year period, says Gary McLaren, director of business development at the Virginia Economic Development Partnership (www.yesva.com), “we’ll give them a grant in return for their investment in Virginia.” In years 6 through 10, Virginia pays a cash grant to the company based on the revenues it has paid to the state.

Other tax incentives in the Old Dominion begin at the local level. One recent bill created tax credits and grants for capital, debt, cash, and stock investments made by technology companies in tobacco-dependent communities. Legislation allowing municipalities to separately classify the personal property of Internet-related companies and Internet service providers was also recently passed.

Local authorities are also sensitive to keeping real estate taxes and machinery taxes competitive, says McLaren. Two years ago, for instance, authorities in Prince William County lowered taxes on corporate computer equipment from $3.70 per $100 of assessed value to $1.50 per $100.

The state has also issued tax credits or exemptions especially valued by tech employers. A few years ago, notes McLaren, executives at America Online, based in the northern Virginia town of Dulles, were considering a major corporate expansion. To help ensure that the company did its expanding in Virginia, state officials allowed AOL to claim tax exemptions on equipment used for media content. Ultimately AOL management green-lighted the expansion in Dulles — reportedly a capital expenditure of $520 million.

Virginia courts the AOLs of the world, says McLaren, “because [the high-tech sector] is an industry that pays good wages.” He notes that technology companies that have set up shop in northern Virginia — now a hotbed for Internet and high-tech businesses — pay median salaries in the $70,000 range. “That’s how you build quality of life,” says McLaren. “You attract high-quality jobs.”

Esther Shein writes regularly for eCFO.

Prime Movers

Top incentives used by state and local economic development agencies.

State Local Modified Incentives for High Tech?
Any incentive 97% 92% 96%
Training or retraining of labor force 39 25 27
Investment in infrastructure 22 26 25
Credits related to sales, property, or employee taxes 17 26 21
Other income tax credits 14 12 16
Capital grants 8 5 7
Investment in technological infrastructure 8 4 7
Utilities 3 4 2
Discretionary credits 3
None of the above 3 8 4

Totals may exceed 100% due to multiple responses.
Source: KPMG

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