Why the Keystone Opportunity Zone Program still exists though it’s an abject failure

“Benign mercantilist” is its own taxable category as part of Pennsylvania’s Keystone Opportunity Zone (KOZ) Program. It costs the city and the school district about $27 million in revenue a year. Philadelphia has foregone a total of $384 million in revenue through the KOZ Program between 1998 and 2012, according to the Controller’s Office.

To understand the initiative’s rationale, imagine the city as a slaughtered animal. Deciding where to set up shop, firms come in and gobble fillet cuts of real estate first: downtown, main arteries, waterfronts, etc.

KOZs cook leftover locations — brownfields, “blighted” neighborhoods and other areas most would consider unpalatable locations to run a company — into scrapple. Tax credits are the secret ingredient in the scrapple recipe.

Businesses that qualify for the KOZ Program pay no or close to no state, municipal, school district, real estate, occupancy, use, wage, income or sales taxes. The breaks ideally increase competition for these less desirable areas, maximize economic activity in the city and create new jobs.

Firms that take part in the Program can thus claim huge tax breaks and at the same time herald themselves as civically minded heroes of industry.

The Pennsylvania General Assembly created KOZs in 1998. Subsequent amendments to the legislation have altered acronyms and extended exemption periods. In Philadelphia, KOZs line Market St., Ridge Ave., North Broad St., Grays Ferry Ave. and the Navy Yard.

The government agencies that manage the KOZ Program have destroyed the documentation necessary to produce a thorough understanding of whether or not the thing actually works.

The Pennsylvania Department of Community and Economic Development (DCED) claimed that firms participating in the KOZ Program generated 9,000 jobs in Philadelphia by 2010. They base this claim on reports by KOZ Program participants who are themselves bound by the honor system alone to tell the truth. A 2009 Congressional investigation found that, statewide, “KOZ jobs data was substantially overstated and not supportable.”

The Controller’s Office placed the number of jobs KOZ-participant firms have created in Philadelphia closer to 3,700 as of 2012. Rather than word-of-mouth, the Controller produced its figure by two different and defined wage tax return data analyses.

Source: Philadelphia Controller's Office

The Controller also estimated that employees at Philadelphia firms in KOZs would need to work for an average of 52 years before the city begins to recover in wage taxes the start-up cost of allotting KOZ credits in the first place. Firms bear no obligation to stay in the city once their exemptions expire.

In response to concerns over limited information available on the KOZ Program’s performance, the DCED in 2009 assured Congress that a “database is being developed and new data are now being collected so that this information can be included in future reporting.”

As of this writing, the DCED’s “Investment Tracker” page lists three projects under the heading “Keystone Opportunity Zone.” The Controller’s Office documented 501 KOZ parcels in Philadelphia alone in 2014. DCED did not respond to requests for clarification.

Firms’ applications for KOZ status would provide excellent criteria by which to gauge the Program’s performance. But as of 2014 in Philadelphia, the Controller found that these important application documents

are only retained for three years before they are shredded, and thus primary sources of information have disappeared… Astonishingly, none of the records have been digitized… [The Philadelphia] Commerce Department’s figures simply did not exist in real time… [The Philadelphia] Revenue Department’s figures were sparse and inaccurate, since companies only occasionally enumerated numbers of employees on tax returns, only total wage taxes due and paid [sic.].

It makes sense that the people responsible for a failing program would want hide its failure. It makes less sense that the topic receives such limited political play.

“Enterprise zone” (EZ) is a label often applied to the genus of tax credit programs to which KOZs belong. It’s an umbrella term for programs that give tax breaks connected to specific real estate parcels under the auspice that these breaks stimulate the economy.

Policy scholar Robert T. Greenbaum and government analyst Jim Landers in a 2009 International Regional Science Review article ask why EZs continue to receive political support although the

rich literature evaluating the effectiveness of EZ programs fails to provide definitive evidence that EZs generate positive economic effects or even improve the welfare of zone residents… Despite the fact that the research literature has failed to generate compelling evidence that EZ programs are effective, the programs remain very popular.

When the KOZ issue does arise, why do politicians like Sen. John Yudichak (D-Dist. 14) lend KOZs hear-no-evil-see-no-evil support despite copious evidence that the initiative hasn’t, doesn’t and won’t work?

Greenbaum and Landers surmise that perhaps the research isn’t clear, and policymakers don’t understand it or don’t have time to read it.

Another way to account for the fact that politicians don’t attack the failing KOZ program is that to do so would mean forfeiting some of their own political power.

Politicians to a large extent control where tax credits go and who gets them. KOZ credits are valuable to politicians in business and real estate development dealings. When a politician argues against tax credit programs like the KOZ, they are also arguing that some of the control they bring to such dealings should be relinquished.

Example: Federal court in 2006 convicted former City Council member Richard Mariano of accepting bribes in return for helping a scrap metal business in his district receive a KOZ contract.

Erie Steel LTD unsuccessfully applied to receive KOZ tax credits in 2003. Firm president Philip Chartock later wrote Mariano three checks to help him pay personal credit card debts.

“Having been corrupted by the stream of $23,000 in payments from Philip Chartock,” Mariano soon after “introduced legislation to make Erie Steel eligible for the tax relief” through enrollment in the KOZ program, according to a Department of Justice memo. The city

accepted that recommendation and included Erie Steel in a proposed tax relief bill that was introduced in City Council in April 2003. In May 2003, Mariano twice voted in favor of the tax relief legislation, neither time disclosing his financial relationship with Erie Steel and/or recusing himself as he was required by law to do.

Similar exchanges likely occur and go uninvestigated all over the state.

Additionally, politicians that attack the KOZ Program in some cases risk getting sued: something, like most other people, they seek to avoid where possible. Many entrepreneurs and real estate brokers who profit from receiving KOZ tax credits have money. As moneyed people often do when denied their desires’ satisfactions, they get litigatey. Politicians that speak out against those desires and/or block their fulfillment become potential targets of that litigation.

Example: Scranton City Mayor Janet Evans first in public and then later in court labeled KOZs “corporate welfare.” She further argued in a deposition that

in the City of Scranton which is mired in debt and has… at least a 25 percent loss of tax revenue due to nonprofits, the city could ill afford to extend KOZ or KOEZ extensions… [W]hen an entity is not paying taxes, that forces the taxpayers of a municipality to shoulder the burden of the difference.

Northeast Development LLC sued the City of Scranton, several council members and Evans for damages after council filibustered that firm’s application for KOZ status. This ultimately cost Northeast a property sale, and to what they refer in their complaint as “permanent damage upon the Plaintiff’s business and business reputation.”

A five-year legal struggle ensued until a federal judge dismissed Northeast’s suit in 2013.

Rachael Spotts provided additional research for this piece.

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