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Smarter, Targeted Tax Breaks That Could Help Resuscitate Central Cities

Office workers’ exodus should be countered with wiser state and federal tax incentives, and there’s a novel municipal bond angle to promote. But cities themselves must step up to stem the urban maladies that feed public fears.

Empty commercial space in San Francisco's Union Square
Empty commercial space in San Francisco's Union Square. (Phil Pasquini/Shutterstock)
Almost every day we read news reports of the demise of center-city downtowns. San Francisco has become the go-to target for critics who assail its street crime, homelessness, office vacancies, office workers’ outmigration and retail business closures. But it’s not just there: Commercial property loan defaults are rising rapidly in many cities. The COVID-19 pandemic and technology’s enabling of work-from-home set the stage of decline for dozens of downtowns, and this year’s viral videos of brazen retail theft gangs just confirmed public perceptions of growing urban dystopia. As with Humpy Dumpty, the question now is whether state and local politicians are capable of putting the pieces back together again.

We’ve all watched the fatuous federal efforts to support urban revitalization with “opportunity zones” that offer tax incentives for new businesses and real estate development in targeted census tracts. Critics have shown that those tax breaks have enriched the wealthy far more than they have helped local residents, and clearly they have not saved the cities where the problem now is an oversupply of vacant urban buildings. Various states have tried their own ways to promote redevelopment with special taxing districts and similar provisions, but too often those incentives rob Peter to pay Paul by depriving schools and counties of tax revenues that fund local infrastructure. None of these programs are sufficiently targeted to counter the magnitude of today’s deteriorating downtown office and retail centers.

It’s time for shock therapy and state-specific interventions. A cookie-cutter solution is not possible, but the basic recipe is transferable. The best fiscal strategy I can offer for California’s center-city problems is not necessarily the right formula for other states, because it relies heavily on state income tax exemptions and incentives. What helps San Francisco and Oakland will be different from what works in Seattle, where there is no state income tax. But a comparable impact could be achieved with other custom-tailored strategies such as targeted state-funded property and sales tax incentives. For Congress, a framework for city-focused, uniform federal income tax incentives can pass only as part of a broader multi-part tax bill, so the urban lobby needs new ideas and training in specific tax technicalities if they ever hope to get serious help from Capitol Hill.

Economic Disaster Zones?


To begin with, an intergovernmental effort must require that the center city itself admit its failures and current shortcomings. The first rule of holes is to stop digging, and the first rule of recovery is to start looking in the mirror. Cities that have allowed social deterioration to impede job-creating business activity must step up to the plate on their own with local actions to address homelessness, street crime, organized shoplifting and related urban maladies and eyesores. Given the technology to work remotely, employees and employers alike will not populate downtown offices if their sidewalks are beyond grungy. The states — and arguably the federal government — could help with programs to provide matching funds for shelter for the homeless, but at the end of the day such efforts must begin at city hall.

Just as we expect local, state and federal officials to declare weather-devastated localities disaster areas, the first step in an intergovernmental approach to urban recovery should be what would amount to an “economic disaster zone” declaration: Local officials must admit failure when that shoe fits. False civic pride and wishful/magical thinking will never bring back businesses, workers, retailers and condominium buyers. If the states are to provide a fiscal framework for durable economic recovery, their legislatures will need to play tough love and set the requirements for securing state-approved or -funded financial incentives in whatever form is appropriate in their jurisdictions. In some states this would focus on property tax breaks. In others it may be business income tax relief. And in some cases it may be incentives for local banks to refinance commercial real estate loans to avoid foreclosures.

Politically, my suggested “disaster zone” designation will obviously need a prettier name to avoid instant ridicule. Even so, the local eligibility declarations must carry the self-awareness and accountability rules cited above if tax subsidies are to be approved outside city halls. Otherwise this looks like rewards for policy failure. Politicians who represent suburban and rural voting districts will need to be persuaded that the state and their constituents all have a vested interest in restoring a vibrant central-city economy with prudent management — that they will ultimately benefit from a stronger city center or suffer from its demise. One need only look at the 60-year fiscal history of metropolitan Detroit to appreciate that truism.

If federal and local taxpayers can subsidize a metropolitan sports stadium miles from the city center with tax breaks, cheap rent and incentives for the owners, then they arguably should do the same for struggling downtown employers — provided there is a regional benefit. The mayors and governors in each state will need to collaboratively strategize their most cost-effective solutions so that lobbying and legislative meddling do not divert and fritter away the benefits of governmental incentives.

One strategy to gain political support from outside the central cities would be state tax incentives for qualifying “center-city exporters” to attract companies and downtown workers (hence, no income tax breaks for remote workers). The key concept here is that urban companies selling their products and services outside their home state would actually contribute more than their fair share to the regional economy. Urban exporters in today’s economy would mostly be high-tech companies, although a revival of professional services, artsy-craftsy enterprises and manufacturing businesses in repurposed urban buildings is clearly conceivable. State-reimbursed property tax breaks for the landlords, scaled in proportion to each company’s percentage of sales derived from out of state, would make perfect sense in such a system.

Another approach would be to suspend or even waive property taxes on urban properties that have gone into loan defaults, with replacement revenue provided by the states to the municipalities and their school districts. While this may appear to be an imprudent reward for careless financiers, the logic of such an approach is that property tax relief makes it easier to work out the debt. Setting up ground rules for such a policy would require serious review of long-standing property tax laws, and should not be undertaken lightly, but this is a case where half a loaf today could bring fresh life to rotting properties where it’s most needed. Solutions must be long term and avoid corruption in the award process.

Rethinking Federal Incentives


Once Congress gets back to writing tax laws after the next election cycle, it should expand its outmoded opportunity zone rules to grant federal income tax breaks to OZ businesses and their workers located in a metropolitan center city. These incentives should target operating businesses only, not real estate development schemes. There are already strict requirements for where qualifying workers reside and how much business is conducted locally, so a simple amendment to permit a federal income tax exemption of perhaps 50 percent for qualifying business owners and their employees over five years or so would be a trivial expense for Uncle Sam, and far more effective than the huge capital gains tax breaks that the 2017 tax law gave away to fat-cat real estate moguls and their cronies. Keeping their lobbyists out of the honey jar will be the challenge here, of course. So the pragmatic sop for them would be to allow building redevelopers an urban-only OZ tax break — but only if the property is then at least half-occupied by qualifying businesses. Anti-sham rules will be needed, for sure.

There’s also a role for Uncle Sam and the municipal bond industry to play here. Having mentioned the enormous tax breaks Congress gives to professional sports stadia, let’s also permit what might be called “center-city distressed commercial refinancing bonds” to be issued as conduit muni bonds by the center cities, with lower interest rates passed through to the office and commercial landlords. To qualify for such cheaper tax-exempt refinancing, the subject properties must have suffered substantial vacancies and document an indisputable need for debt restructuring. Landlords would be required to pass along a chunk of the savings to their tenants, who in turn must occupy the buildings with returning workers. To prevent runaway issuance, a limit of such bonds per city could be based on its metropolitan population and approved statistical measures of commercial vacancies.

Lest the reader come to believe I am oblivious to the mischief and waste that can come when governments try to replace the “invisible hand” of free market economics that epitomized the foundational works of Adam Smith 250 years ago, the foregoing strategies for public intervention must all meet a common and stringent litmus test: that the salvation and redeployment of wasting urban assets will benefit the regional economy more than the resources thus diverted would have achieved elsewhere by simply letting the failures take their course as they did in Detroit. Building such an acid test into legislative tax logic would be a tall order but not insurmountable if legislative analysts and budget departments do their jobs with the analytical societal cost-benefit tools available today to economists who focus on public finance.

Other solutions may arise from creative, rational discussions among the mayors, governors and their economic development teams. One size won’t fit all, although at the federal level a single approach would be necessary in Congress in order to get uniform incentives built into the U.S. tax code. Getting federal help must require proof that the states and cities are themselves chipping in to help solve the problem. As a chain is only as strong as its weakest link, a “whole of government” partnership is called for here.



Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management. Nothing herein should be construed as investment advice.

Girard Miller is the finance columnist for Governing. He can be reached at millergirard@yahoo.com.
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