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Study: Foxconn likely to be an economic drag on Wisconsin

Project could depress state economic activity by tens of billions of dollars

December 20, 2019 by Richard Moore

A study released last month by researchers at the conservative Mercatus Center, a free-market think tank at George Mason University, has concluded the state’s billion dollar-plus subsidy deal with tech giant Foxconn isn’t working and won’t, and could cost the state tens of billions of dollars in economic growth over the next 15 years.

The study, “The Economics of a Targeted Economic Development Subsidy,” by researchers Matthew D. Mitchell, Michael D. Farren, Jeremy Horpedahl, and Olivia Gonzalez, concluded incentives such as targeted tax relief, targeted regulatory relief, cash subsidies, and in-kind donations of land and other valuable goods and services just don’t work, and they used the Foxconn deal as the basis of their research.

“In this paper, we review the economic case for and against targeted economic development subsidies, using Wisconsin’s $1.2 billion to $3.6 billion subsidy to Foxconn to illustrate these points,” the researchers wrote. “We show that under realistic scenarios the subsidy may depress state economic activity by tens of billions of dollars over the next 15 years.”

As the researchers noted, the state built the deal around a combined $2.85 billion in refundable payroll and capital expenditure tax credits, while localities agreed to a $764 million site development subsidy (which subsequently expanded to $911 million), funded via tax increment financing. The state has agreed to underwrite 40% of these loans if the local government is unable to pay them off.

“Beyond these financial incentives, the state also exempted the company from certain wetland regulations, permitting it to circumvent the standard environmental impact reports and to discharge material into nonfederal wetlands without a permit,” the researchers stated. “It also authorized over $332 million in electric and gas utility infrastructure improvements to service the plant, the costs of which will be borne by utility customers.”

Finally, the researchers observed, the village of Mount Pleasant declared 2,800 acres as ‘blighted,’ despite the area’s comparatively low crime rate, and has spent $160 million to acquire property through eminent domain in order to transfer it to Foxconn.

In return, the researchers continued, the company and its partners initially agreed to invest $10 billion in a “Generation 10.5” LCD manufacturing plant, which specializes in making LCD displays 65 inches and larger. The project was expected to take six years to complete, and the company only promised to employ 3,000 workers, though it believed it had the potential to employ up to 13,000 workers.

Give me a fourth, I’ll give you a third

The researchers observed things weren’t quite as bright as the company promised even from the beginning.

“Despite the July 2017 promise of a $10 billion investment with 13,000 workers, the final agreement that was inked in November of that year allowed Foxconn to claim the full subsidy with only $9 billion in investments and 10,400 workers,” they wrote.

The following July, things got even worse.

“Then, in the summer of 2018, Foxconn scrapped plans to build a Generation 10.5 LCD plant, saying that it would instead build a Generation 6 facility to make smaller LCDs for devices such as tablets, mobile phones, and smart watches,” the researchers wrote. “… Although the company maintained that it still planned to invest up to $10 billion in the facility, industry experts have said that a Generation 6 plant would require a $2 billion to $3 billion investment, rather than a $10 billion investment.”

All that was not surprising, the researchers wrote, because a recent state audit found that, on average, firms receiving Wisconsin subsidies create only about 34% of promised jobs. Indeed, the researchers said, a Generation 6 plant would require only one-fourth as many workers and only one-fourth as much capital.

To be sure, fewer workers and less investment would mean the company would receive fewer subsidies, but still, the researchers wrote in their analysis, the costs to Wisconsin would be substantial — more than $1.1 billion in subsidies, or a third of the total subsidy package for delivering only a fourth of the jobs and capital investment.

Multiplying the best scenario

As the researchers pointed out, the most common argument for targeted subsidies is that they will create a multiplier effect in the local economy, that is to say, the subsidies support direct economic activity, which in turn spurs other economic activity. 

“The idea is that all economic activity has a ‘multiplier effect,’” the researchers wrote. “When a firm builds a new production facility, it creates new demand for labor, capital, and materials. The workers, in turn, create new demand for goods and services.”

In other words, the subsidy will create a ripple effect through the economy beyond the boundaries of the supported project.

In the case of Foxconn, the researchers wrote, one study commissioned by the Wisconsin Economic Development Corporation, the agency that negotiated the subsidy, employed an input-output model to estimate that the plant and its presumed 13,000 employees would create demand for an additional 18,057 workers in supporting industries, the researchers wrote. 

“Foxconn itself had projected that the plant and its employees would create demand for an additional 22,245 workers,” they wrote.

In addition, the Center for Research on the Wisconsin Economy at the University of Wisconsin, led by economist Noah Williams, calculated that over the course of 15 years the Foxconn Generation 10.5 plant would add about $39 billion in additional output, or GDP, to the state’s economy, or $13.80 in new GDP for every $1 of subsidy, the study stated. That would translate into $9.8 billion in additional GDP for a smaller Generation 6 plant.

But, the researchers argued, the multipliers have been misunderstood. For one thing, they argue, the value of new GDP related to the subsidies that Williams projected is only true if the subsidy was 100% decisive in Foxconn’s decision to locate to Wisconsin.

That’s highly unlikely, the researchers argue.

“When multiple jurisdictions bid on a proposed facility, companies often do not choose the highest bidders,” the researchers wrote. “For example, in selecting its second headquarters, Amazon rejected much higher incentive packages offered by Cleveland and Ohio ($3.5 billion), Newark and New Jersey ($7 billion), Maryland ($8.5 billion), and Dallas Fort Worth Airport ($23 billion) to initially select New York ($3 billion) and Virginia ($1.05 billion), only to later walk away from New York.”

Indeed, the analysis stated, labor costs seem to be a more important concern, and that seemed to be the case in Foxconn’s decision to scale back its plans for a Generation 10.5 plant in Wisconsin. Indeed, they argue, if the subsidies were only 2% decisive and Foxconn opted for a smaller Generation 6 plant, the GDP creation over 15 years would be a mere $196 million.

Of course, that latter outcome and Williams’s best scenario are the two extremes, and the truth may be somewhere in the middle. At the very least, the researchers wrote, there is “vast uncertainty” involved in such estimates. The point is, the study points out, the Williams’ analysis uses only the rosiest assumptions to project the benefits of the subsidies.

Half empty or half full

But the benefits of multipliers, whatever they turn out to be, are only half the story, the study states. To truly analyze the values of a targeted subsidy, the costs of the subsidy must be considered as well as the benefits of the subsidy.

First and foremost, the study states, in order to fund Foxconn development, the state first has to remove $3.6 billion from the Wisconsin economy. The money has to come from somewhere, and that somewhere is the state’s taxpayers.

And that requires a trade-off, according to the study.

“The logic of a multiplier is that economic activity indirectly creates other economic activity; a new production facility and its employees create demand for products and services offered by suppliers and other producers,” the researchers wrote. “This logic, however, also applies to the resources that are used to fund the subsidy.”

In other words, the study continues, just as the workers at a Foxconn factory create demand for other products and services, taxpayers also create demand for other products and services, and, with $3.6 billion less in their pockets, these taxpayers create less demand for other products and services. 

That is to say, the researchers wrote, there is a negative taxation multiplier also associated with the subsidy and the real question is whether the negative multiplier is greater than the positive multiplier.

That’s standard economic analysis, the researchers wrote, but the journalists and industry leaders who repeated the best-case estimates seemed not to appreciate that they were telling less than half of the story.

“The Wisconsin Technology Council, for example, repeated the $39 billion gross estimate but presented it as if it were a net estimate of the economic effect of the subsidy,” the analysis stated. “At best, when reports do acknowledge a cost they state only the fiscal cost of $3.6 billion, failing to acknowledge that the $3.6 billion would have generated its own economic activity through its own multiplier.” 

The researchers also point out that subsidy supporters often argue that firm location decisions can create positive benefits by building “industry clusters” that lead to enhanced knowledge sharing, indirectly accelerating the development of valuable new ideas.

“It is commonly argued that this occurs when several firms from the same industry are ‘clustered’ together in the same region,” the analysis stated. “If enough firms in the same industry co-locate, creating a critical mass of demand for production inputs and professional services, they will attract suppliers to that region as well.”

But, in fact, the researchers argue, most clusters form independently of government action, and sometimes in spite of it.

“This is especially so when firms cluster in an area to take advantage of local conditions afforded by the natural environment, the workforce, suppliers, or the customer base,” the analysis states. “No inducement is necessary to encourage tech firms to locate in Silicon Valley or financial firms in New York City or wineries in Napa.”

In fact, the authors argue, subsidies may discourage the sort of beneficial clustering that would occur naturally, instead causing overspecialization in a single area or industrial sector, leaving the region economically vulnerable if there is a downturn in that sector.

“Detroit, which during the first half of the 20th century was the archetypal cluster, also showed the problems that can arise from an economy that is overly dependent on a single industry,” they wrote. 

What’s more, the analysis continues, there’s little reason to believe policymakers will encourage the right the kind of industrial cluster, and Foxconn might be the perfect example as project proponents have publicly touted the creation of a new Silicon Valley, which they dubbed “Wisconn Valley.”

“Once a cluster like Silicon Valley has already been created, however, a second, third, or fourth cluster around the same industry in another location is less likely to be successful, not more so,” the authors wrote.

Simply put, the authors argue, if there was a natural comparative advantage driving the creation of a tech manufacturing cluster in southeastern Wisconsin, there would be no need for a subsidy as an inducement for firms to locate there. 

Moreover, they wrote, the targeted subsidy may discourage another sort of clustering that would occur naturally — say, the region’s nascent water industry — and may encourage the region to overspecialize or to specialize in a way that is not consistent with its comparative advantage.

A better way

The authors not only critiqued the potential perils of the Foxconn subsidies, they offer alternatives scenarios they think would have better benefitted the state. One option was that, instead of spending $3.6 billion on Foxconn, that money could have been used to enact a generalized reduction in across-the-board tax rates across the state.

For example, the authors wrote, Wisconsin’s corporate income tax (CIT) will collect about $15.79 billion over the course of the next 15 years from about 16,000 firms that pay the tax now.

In lieu of subsidies for a Generation 10.5 plant, the state could have instead reduced its CIT rate by about 22%. 

“The state taxes corporate income at a flat 7.9% rate, so this means that it could have instead reduced the rate to about 6.17% and kept it at this lower rate for a decade and a half,” they wrote.

Then, too the state could have used that money to lower tax rates in ways that would have greatly benefitted northern Wisconsin, too.

“Similarly, the state’s flat fuel tax of $0.309 per gallon could be lowered by 18.92% down to $0.25 per gallon,” the authors wrote. “Or, more broadly, overall tax revenue could be reduced by 1.07%.”

Or, the study found, in lieu of the subsidy, the state could have reduced personal income taxes by more than 2%. And what if, instead of subsidizing Foxconn, the state had instead lowered its sales tax? 

In that scenario, the authors wrote, the state could have reduced its sales tax from 5% to 4.84%. 

All this is important, the authors continue, because taxation creates what is known as “deadweight” loss, that is to say, taxation discourages the taxed economic activity, and that lost activity is the deadweight loss.

To say that another way, the authors point out that, in lieu of the Generation 10.5 plant subsidy, Wisconsin could have reduced all its taxes by 1.07%, and that means, in order to fund the subsidy, Wisconsin taxes will be 1.08% higher than otherwise necessary over the long run.

The lost economic activity due to those unnecessarily higher taxes is the deadweight loss of the subsidy. But what is that likely to be? 

Well, the authors wrote, relevant research indicates that if a state “raises its taxes by 10%, the estimated long-run effect would be a reduction of business activity between 1% and 6%.” 

That’s not an insubstantial loss, the authors calculated, given that Wisconsin’s GDP from 2018 to 2032 is estimated to total $6.3 trillion. 

“The higher taxes to fund a Generation 10.5 plant subsidy will be associated with economic losses in the range of $5.7 billion to $34.3 billion over that time period,” they wrote. “Higher taxes to fund the subsidy for a Generation 6 plant will be associated with economic losses in the range of $1.8 billion to $10.6 billion.” 

The bottom line is, the authors wrote, the gross decrease in GDP associated with the taxes that pay for the subsidy have to be calculated along with the gross increase in GDP owing to the subsidy. 

Of course, as the authors explain, there are a range of scenarios of what might happen in the real world — how decisive the subsidy was in Foxconn’s decision to come to Wisconsin, whether the deadweight loss due to unnecessary taxation was low or high — and so the researchers developed multiple scenarios for the possibilities, ranging from best-case scenarios on all factors, to worst case to in-between.

What they found was not comforting.

“If we restrict our attention to the Generation 6 plant, 8 of the 12 scenarios suggest a net loss from the subsidy, and just 2 of what we regard as the realistic scenarios are positive,” they wrote.

Indeed, with a Generation 6 plant, the most realistic scenarios suggest a net impact loss of state GDP from 2018-2032, ranging from $1.2 billion to $5.9 billion.

If the generation 10.5 plant was built, both the potential benefits and potential losses would be greater. Using the most realistic scenarios, the researchers determined that the state would surrender anywhere from $369 million in GDP loss to $19 billion.

“The worst-case scenario occurs in the event that Foxconn builds a Generation 10.5 plant, the expected value of the subsidy is on the low end of the range (because of a high probability that the company would have made the investment anyway), and the deadweight loss associated with taxation is on the high end of the range,” they wrote. “In this case, the expected net economic effect of the subsidy is a GDP loss of nearly $34 billion over 2018–32.”

In the best-case scenario — also not considered realistic — the expected net economic effect of the subsidy would be a GDP gain of nearly $34 billion over 2018–32. That’s still $5 billion less than proponents of the subsidy have touted.

Richard Moore is the author of the forthcoming “Storyfinding: From the Journey to the Story” and can be reached at richardmoorebooks.com.

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