The programs are so complex, and the promises so appealing, that states typically don’t take a close look at them until it’s too late.
By Jen Fifield
This is part one of a two-part series.
In rural communities across the country, jobs are disappearing and people are moving away, driving a desperation that helped elect Donald Trump president.
But as state lawmakers look for ways to bring life to these long-struggling areas, many are falling prey to a complex economic development approach, pushed hard by investment firms that stand to benefit, that has failed to live up to its promises.
The so-called rural jobs bills have been proposed in at least 11 states this year, and last week in Utah, Gov. Gary Herbert, a Republican, signed one into law. Under the bills, state tax credits are awarded to companies that agree to invest in or loan money to funds set up by investment firms or other brokers. The funds then invest the money in rural businesses. The proposals are the latest iteration of an approach that at least 20 states and Washington, D.C., have turned to in the last three decades.
But states that have evaluated the multilayered subsidized lending programs — originally CAPCO (certified capital companies) programs and later New Markets Tax Credit programs — have found that they failed to deliver promised jobs and tax revenue.
Three firms — Advantage Capital Partners, Enhanced Capital and Stonehenge Capital — have led the lobbying for the programs and have been the main participants in several states. (Advantage is lobbying for rural jobs bills this year. Enhanced said it is not lobbying for the bills this year. It’s unclear whether Stonehenge is.) The laws, through which states have awarded billions in tax credits, are generally structured in such a way that these and other firms that participate can profit from the deals even if the businesses they fund never create another job.
The programs are so complex, and the promises so appealing, that states typically don’t take a close look at them until it’s too late, according to 10 economists and policy analysts who have studied them. Many critics, such as Steven Miller, senior vice president of the Nevada Policy Research Institute, call the programs “schemes.” Miller says he expects a public backlash once they “have gone belly up and taxpayer dollars have been used for private benefit.”
According to Miller, supporters sell the programs to the left as a way to help the economically downtrodden, and to the right as a way to boost business.
“It’s like magicians,” he said. “They are waving sparkly things so people will look at them and they won’t look at this other stuff.”
Representatives of the three firms declined to comment on the record in person or by phone. But they said via email that the programs have created a pipeline for private dollars to flow to businesses in need of investment, creating or saving thousands of jobs. Advantage and Enhanced also pointed out that many states have chosen to renew their programs.
In the last 15 years, reports conducted by state auditors or paid for by the state found that programs in Alabama, Missouri and Washington, D.C., would not create as many jobs or as much state revenue as promised, and recommended the programs be shut down. In Colorado, an audit also recommended the program be shut down. In New York, a state report found that the program there had created fewer jobs than promised, and officials argued against an extension. State auditors and economic development officials in Florida and Louisiana concluded they did not have enough information to judge the success of the programs and recommended changes to increase benefits to the state or to make the programs more transparent.
Colorado and Florida chose not to spend the second round of funding that had been approved for their CAPCO programs. In 2004, then-Colorado Gov. Bill Owens, a Republican, said his state’s CAPCO program had benefited private businesses but not Colorado. “We can’t mend this program,” Owens said. “We must end this program.”
Reporters at the Palm Beach Post in Florida, the Portland Press Herald in Maine and the Journal Sentinel in Wisconsin have revealed problems with programs in their states, including questionable deals and sizable profits made by investment firms.
Only one recent state-funded study has concluded that the economic benefits of a program outweighed its costs: A Maine study released earlier this month found the state’s New Markets program would generate millions more in tax revenue than the state offered in tax credits. But some analysts cast doubt on its conclusions, arguing that the authors used methods for counting jobs, backed by the investment firms, that overestimate the number of jobs directly linked to the tax-credit program.
CAPCOs were introduced in the 1980s, and they generally aim to support small or new businesses by increasing their access to capital. State New Markets Tax Credits, which came later, are typically intended to boost economic development in low-income areas. Under the new rural jobs bills — being considered in Arizona, Georgia, Kansas, Kentucky, Massachusetts, Minnesota, Missouri, New York, South Carolina and Washington state — investments would be made in small, rural businesses.
The idea behind the programs is that they will generate economic activity that exceeds the cost of the tax credits.
Pennsylvania last year created a rural jobs program that will provide up to $90 million in state tax credits. Kentucky, Missouri and New York also considered rural jobs bills last year, but those did not become law.
States employ many strategies to boost economic activity and create jobs. But these three tax-credit approaches have several characteristics in common that make them unusual.
Unlike many other economic development programs, in which the state directs the flow of money, these programs rely on private firms or nonprofits — often investment firms or their affiliates — to act as brokers, directing the investments and loans made under the program.
Generally, under all three approaches, states offer tax credits to companies, including cash-rich insurance companies. The tax-credit recipients make investments or loans to funds that investment firms or others set up in that state. The funds then invest the money in local businesses.
The funds set up by the investment firms don’t have to fully repay the companies that give them money. Instead, for the companies that make the loans or investments to the funds, the tax credit from the state covers some or all of the repayment.
That means in most states, if the local businesses pay back the money, the funds get to keep at least some of the principal, along with any interest or profit. (In some states, the fund must pay the state part of the profit.) On top of that, the funds can earn fees related to the management of the funds or the transactions. (Under New Markets programs, a portion of the loan to the local business is sometimes forgiven.)
The companies that put money in the funds — and receive the tax credits — generally have little to no risk related to the actual investments made in local businesses, because the tax credits usually provide a dollar for dollar match, according to a report from ratings agency Moody’s.
Another difference between these programs and other development strategies is that the state does not choose which investment firms may participate based on their investment plans or their track record with similar investments. Instead, the investment firms are selected on a first-come, first-serve basis, until all of the credits have been assigned.
This benefits well-connected investment firms, according to Julia Sass Rubin, an associate professor at Rutgers who has studied the use of equity capital for economic development, including these programs. The firms that have participated in the programs for years in multiple states have long-standing relationships with the cash-rich companies that qualify for the tax credits, Rubin said, and are often able to quickly secure large commitments from them.
The money flows differently depending on the program, and the specific deal, and often it’s difficult to determine how much the businesses actually receive, said Wesley Tharpe, research director at the Georgia Budget Policy Institute.
Under Colorado’s CAPCO program, for example, the state gave out $100 million in tax credits, but the state audit found that no more than $44 million was available for investment in local businesses.
Policy analysts say it’s also difficult to estimate how much investment firms make from their role as middle men. The recent Maine New Markets report found that the six funds that participated in the state’s $76 million tax-credit program pocketed at least $16 million in fees and charges — the bulk of which went to one of the firms. (The report didn’t say which one.)
The programs’ stated goal is to support businesses that are new, small, or in struggling areas, which are often a bigger risk. But the structures create an incentive for investment firms that want to maximize their profit to make low-risk loans, Rubin said.
For example, Alabama recently studied its CAPCO program, which began in 2002, and concluded that “the resulting portfolio is less risky than would be the case in a typical venture capital portfolio.” Only about 19 of the 94 businesses that received investments got any funds in their first year of operation, the report found, compared to 20 businesses that received investments more than nine years after they were founded.
Advantage, Enhanced and Stonehenge dispute that the programs are set up in a way that encourages low-risk investments, saying they often invest in small, new or growing companies that wouldn’t otherwise be able to secure investments. Advantage also pointed out that the programs have evolved over time, and now include additional protections for states.
Creating Rural Jobs
The details of the rural jobs programs now being considered are still being worked out. But the proposals have much in common with CAPCO and New Markets programs, according to policy analysts who have studied them.
Tharpe reviewed the rural jobs bill proposed in Georgia this year. “It creates a complex new funding mechanism to funnel state tax credits to financial intermediaries promising to invest in companies that create jobs,” he said, “with little apparent transparency or accountability to ensure the state gets a good return on taxpayers’ investment.”
In Utah, the new program will offer up to $24.4 million in state tax credits, if funds raise $42 million to be invested in rural businesses. (This is similar to state New Markets programs, in which states generally provide tax credits worth less than the total raised by funds.) The goal of the program is to create at least 600 new jobs in rural areas. At that number, the state would pay $40,666 in tax credits for each new job.
Republican state Sen. Ralph Okerlund, who authored the legislation, told fellow lawmakers this month that the program would be a “real game changer” for rural areas, which are home to 10 percent of the population but only 1.1 percent of the private equity investment in the state since 2000.
The governor set a goal this year of bringing 25,000 new jobs to rural areas of Utah in the next four years. The program will help meet that goal, Okerlund said.
New York Veto
New York is one of just a handful of states that have independently reviewed the net number of jobs created through its investment program. The state created a CAPCO program in 1997 and renewed it four times, in 1999, 2000, 2004 and 2005, offering a total of up to $400 million in tax credits.
In 2011, a state report found that 123 of the 184 businesses that received investments under the program had seen a total net increase of 188 jobs. Forty-five of the businesses added employees, while the rest either lost jobs or saw no change. The state could not get data for the 61 others.
The program was intended to reach businesses that were new, small, or in underserved areas. But the report noted that the investments were split about equally between small, medium and large businesses, and more than half were in New York City.
The state’s job numbers were very different from those cited in an April 2010 study paid for by the National Coalition for Capital, a CAPCO advocacy group. The coalition, which pushed for CAPCO bills in multiple states, was headed by Ben Dupuy, who went on to work for Stonehenge and now works for Enhanced.
The coalition said that by 2009, companies had claimed $289 million in New York tax credits and the program had created or retained 34,878 jobs.
But policy analysts say the methods used in this and other reports paid for by the programs’ supporters often inflate job numbers by counting all jobs retained or created by companies after they received investments under the program, even when the companies also received other investments.
As New York considered another round of funding in 2011, the state’s insurance and budget departments and its economic development arm, Empire State Development, recommended against an extension, citing the state’s report.
Empire State Development advised Democratic Gov. Andrew Cuomo that the state should instead try to make the program more effective by creating more specific goals and benchmarks. In 2011, Cuomo vetoed a bill that would have given out up to $150 million more in tax credits for CAPCOs.
Advantage, Enhanced and Stonehenge all cite numerous examples of businesses that benefited from the programs.
In Missouri, for example, affiliates of Advantage leveraged $1.95 million in state tax credits in 2010 to make a total investment of $5 million in five companies, including PayIt, a Kansas City startup that creates mobile and web applications for state and local governments, according to state data. PayIt CEO John Thomson would not say the amount of the investment his company received. But he said the funding allowed the company to move into a larger office and hire more people. “We’re growing really fast,” Thomson said.
But not all of the investments made under the programs are made in small or new businesses.
Oregon, for example, created a program in 2011 that will give out up to about $78 million in tax credits meant to support investments in low- to moderate-income communities.
In deals managed by a Stonehenge affiliate, the state committed $6.2 million in state tax credits to spur investments of $16 million in Walgreens and Kroger, well-established national chains. The loan to Kroger went to an unspecified grocery store in Warrenton, along Oregon’s north coast, helping it “expand its food department by 54.7 percent thus increasing the access to fresh and healthy foods to low income individuals,” according to information Stonehenge reported to the state. The only Kroger store in Warrenton is located in a ZIP code with a poverty rate of 14.4 percent, which is lower than the state’s average. Kroger did not respond to a request for comments.
The loan to Walgreens provided “capital expenditures and working capital” for 10 stores, nine of which are in low-income communities, according to information Stonehenge provided to the state. Walgreens qualified because it is “a business investing in jobs and revitalization in low-income communities,” said James Graham, a Walgreens spokesman. The loan improved “access to economic opportunity, health care and retail shopping for food and other daily necessities,” he said.
In Arkansas, the state created a New Markets program in 2013. Grant Tennille, former director of the Arkansas Economic Development Commission, told the Portland Press Herald that he was opposed to the program in the beginning, but the bill had too much momentum to stop.
“I’m not going to tell you that all the projects that got done are bad projects,” Tennille told the paper last year. “There are some great ones. My objection all along has been that this is a woefully inefficient way for the state government of Arkansas to try to inject capital into the economy. … Half [of the money] is disappearing into the maw of financial institutions and lawyers.”
The Alabama CAPCO study and a separate state-commissioned report on the New Markets program described both programs as “woefully inefficient” and lacking transparency and accountability. (The Pew Charitable Trusts, which also funds Stateline, helped Alabama write the request for proposals for the studies.)
The CAPCO program, which was created under a 2002 law and expanded in 2007, included tax credits of up to $200 million. The state’s New Markets program, established under a law passed in 2012, had committed tax credits worth $234.4 million as of 2015, according to the state report.
Matthew Murray, a professor of economics at the University of Tennessee who helped write both studies, said that no matter how researchers looked at the data, the state was not getting a meaningful return on its investment.
“I would encourage states to go back to square one and more carefully consider what your objectives are and more carefully consider these incentives in order to promote accountability,” Murray said.
According to the CAPCO report, 94 Alabama businesses received investments or loans totaling about $175.3 million under the program and created 1,905 new jobs that could be connected to the credits. The report said that means each job created cost the state about $92,000 in tax credits.
The New Markets report notes that it’s difficult to determine how many jobs the program created. According to the report, investments or loans were made to 31 Alabama businesses. Twenty-nine of those had 1,331 employees in 2015, and job data were not reported for the other two.
Becki Gray, senior vice president at the John Locke Foundation, a North Carolina-based think tank that advocates for a limited role for government, said economic development programs should be easy to understand and transparent.
Her radar went up, she said, when a New Markets bill was introduced in North Carolina last year. She found it to be confusing at first, she said, but now she realizes it is “an investment scheme.”
“It seems to me when you start drawing those squiggly lines of where the money is going, and where the percentages are added on, and percentages are taken off, at every one of those turns it feels to me like there is room for somebody to take advantage — for somebody to hide something.”
In Wisconsin, former Republican state Rep. David Ward told the Journal Sentinel in 2011 that when his state started a CAPCO program in 1997, there weren’t many in state government who understood venture capital. Two other lawmakers — Republican Glenn Grothman, who was a state senator at the time and is now a U.S. representative, and former independent state Rep. Bob Ziegelbauer — told the paper they regret voting for the bill.
In Washington, Democratic state Sen. Maralyn Chase said she was immediately skeptical of the rural jobs bill that is being considered there this year. She is already queasy about the amount of tax credits the state hands out, and she grew more suspicious once she learned about how CAPCO and New Markets programs had performed in other states.
Nevertheless, it was difficult to discount the promised benefits, she said, because many of the people in rural parts of the state are desperate for help.
“Do you deny families jobs because the crook is trying to get in there?” she said. “Or do you look the other way, and say, ‘Let’s get back to work.’ ”
She voted against the bill.