Beyond compliance-testing, I concluded long ago that economic development audits have extremely high audit risks and only produce uncertain benefits.
My corporate-speak bottom line is this: economic development spending is giving public dollars to a few business people with the hope that it will enrich the entire community. I look at economic development programs as a form of venture capitalism. In those enterprises, a 10% success rate is the norm, but those 10% of businesses are so profitable that they make up for the 90% that are losers. One might think that auditors would easily find economic development failures, but there is no reliable bottom line so the story is never that simple.
The most important audit question in this area is whether the public actually benefited from the spending of public dollars specifically intended for economic development purposes. To answer is perilous because of the many variables at play in a local economy, and almost as many in a spending strategy. When the fire chief promises better response times if a new station is built, that promise is simple, and fulfillment is measurable. An audit can compare before and after times between the caller contact with 911 and the arrival of a crew at addresses in the area.
Defining economic benefit is difficult. Is it more jobs? Increased property values? More business start-ups? Increase in tax revenues? Attracting more outside investors? Where does equity fit in any considerations?
And how long does the public have to wait to see its benefits? How long must the dust settle on an industrial park? How long must we wait after tax abatements, or extensions of streets, water, and sewer lines to take our measurements? Should we think like a venture capitalist and evaluate multiple projects to see if they collectively produce benefits, even at a 90% failure rate?
I’m sorry to ask all these questions rather than answering them, but I have no definitive answers. In my experience, when we asked the creators of these incentive packages to define success, they were vague and evasive. It would also not surprise you that economist answers were vague and often contradictory. And one lesson learned is that whatever economist course of measures you choose, the advocates of the unchosen will eagerly question and contradict your audit conclusions when the report is issued.
Of course, we also face the usual challenges of data. Reliable data from federal sources can lag several years, so add that time onto the dust-settling phase, or rely upon more shaky local sources. Relevance is another challenge because the geographic lines you choose to draw may not match the reporting areas of data. And then there are some desired outcomes that have no data.
Even if you have some good data, you still face the “but-for” dispute like we heard in one audit of economic incentives. Would the new jobs you measured have been created regardless of economic development efforts? If the economy is improving, what did this public spending really accomplish? To anticipate this challenge, you try to find a comparable area and measure job change there as well to see if there is a difference between the two. Again, you face a challenge from those pesky economists who will say, “Oh, those incentives just attracted the jobs to the areas of focus and away from other areas you didn’t measure. You can’t conclude there was a positive overall benefit for the public.” This is essentially what they said after we conducted an audit of tax increment financing when the economy was weakening and found that the subsidized areas lost fewer jobs than other areas.
Many of you serve in communities where promises were made about a sports stadium, or streetcar line, or convention center. They weren’t just economic, they were mixed with social or environmental goals. You’ve heard them. Gaining a professional sports team (or keeping it) will make our community a player on the national stage. Getting people out of cars into a convenient, electric-powered transit alternatives are good for the environment. Bringing conventions to our community will create entry-level and managerial jobs in close proximity to an area that needs them. One public official called it “urban bling” as if it were a desired and deserved adornment from Tiffany’s. Can we declare success when we find the program achieved those social goals, even when the economic ones are iffy? Sorry, I’m asking another question.
Time and circumstances play a big role in successfully marketing economic incentives. They often get approval because public officials like to signal that they are making good efforts to counter an economic downturn. We need to show the public we are doing something, they seem to plead. Even if you had a previous economic development audit—and its recommendations—to caution public officials about their ideas, the officials will discount such a warning. They’ll be inclined to believe these are different times, different players, and a different incentive strategy. And of course, some economists will support their view. Officials will also throw desirable social goals into the mix to help justify it all and, by doing so, complicate any evaluation.
In reality, the money involved is a pitifully small injection into the local economy. And most often the economy springs back before the construction is underway or the jobs program has produced its first graduate.
Even with success, an auditor might question the expense. We audited a tax abatement program to spark housing development in a warehouse district in Portland. The district exploded with thousands of new condominium units and lofts in converted warehouses. Compliance problems were found, first by the county and then confirmed by our city audit, but other questions were also raised. The most frequent question was whether the tax abatements were too generous. I characterized the question as, “You got the fire started, but did you need that much kindling?”
So, committing audit hours to evaluate economic incentives won’t produce universally respected conclusions and, for elected officials, the recommendations probably won’t matter.
I know my observations may discourage auditors from taking on these types of audits but we should be good stewards of our own audit resources and work towards producing the greatest benefits for the public, just as we want other agencies to do so with theirs.
Compliance-testing of economic incentives is challenging in a different way. The rules and expectations around incentives may be unstated, or ambiguous, which makes it difficult for auditors. If everyone were committed to the lofty mission and vision of the program, then that aspiration could compensate for the vague requirements. But we can’t rely upon good intentions because the operating and cultural practices of business don’t usually align with the expectations of government.
In business, the bottom-line profit is the measure of success, so companies focus on the cost, timeliness, and quality of their work. Of course, we have the same expectations in government, but we expect more. Government’s foundation is a code of ethics that puts the public first. Just like our independence standard, we expect all government employees to act objectively and impartially, in mind and appearance. In business it wouldn’t matter if the department manager’s brother-in-law offered the best deal for trucking services, but in government it would.
To know if government agencies are achieving any of those public goals, we also have accountability expectations, which means written procedures and record-keeping made accessible to auditors, reporters, and curious citizens. Yet businesses are very private about their operations and earnings. From their perspective, procedures and documentation are proprietary, unnecessary for many decisions, and examples of wasteful red tape that just slows things down.
Any kind of collaboration becomes complicated when government and business—with their different perspectives—try to engage in a transaction, but particularly so with economic development efforts. Both will likely need to compromise on some of their values and practices. For example, if certain businesses are getting subsidies, the agreement should contain an audit clause providing auditors with full, unfettered access to all financial and operational records of the business. If your government had added some social goals such as job creation for local youth or minorities, then customer, contractor, and personnel records must be made available. Businesses may reject the intrusion, but without accountability there can be no assurance of compliance.
If the compromise favors business, then the government must abandon some of its own principles and expectations for detailed verification and accountability. There are risks that a whistle-blower on the business side will show the consequences of the government’s bargain and the public will be appalled with what they are paying for. We have all heard the stories of sweetheart subcontracts with contributors to officials’ campaigns; or poor working conditions and paltry pay for employees; or a combination of the two. If you started an audit and that whistle-blower contacted your office, what would you do? Just a hypothetical question of course. Declaring that the topics are outside the scope of your audit seems like a good idea—until the whistle-blower contacts the reporter who calls you to ask why such serious allegations were ignored.
Another type of compromise is needed for social goals such as assistance programs for small and minority-owned businesses. Agencies may not realize these contractors need additional coaching and assistance because they lack the expertise to run a new or small business and navigate the red tape, or produce a quality product. Or they may simply cut corners. When we hire someone fresh out of college, we expect that employee will need much more guidance and training. The relationship with contractors is supposed to be different. That arm’s-length relationship breaks down for these emerging businesses, which hope to grow their capacity to perform but need more monitoring, extra coaching, and greater tolerance of lapses. What does an auditor say about the failures of these contractors, or the inconsistent application of contract requirements by the agency?
Auditors face more serious challenges when economic development programs raise suspicions of fraud. Many of these programs are newly hatched ideas that lack the painfully learned rigor of experience. Again, bottom-line profits are the strong motivator for participating businesses, probably more than the ethical or social expectations of the program. While the government agency may establish adequate controls on its own efforts, it can’t easily reach into the private side of the financial transactions or bookkeeping, which leaves many unanswered questions.
If auditors suspect malfeasance by an employee, any bribes or other transactions will be inaccessible in personal banking accounts, if recorded at all. Perhaps your office has subpoena powers, but even then, caution is called for. Standards make very clear that in these cases auditors should immediately consult with the appropriate justice agency, which likely means you hand over your work papers and withdraw.
Over the years, I’ve been involved in several situations where we had serious questions of fraud involving programs intended to boost a geographic area, a business sector, or a contracting relationship. A few ultimately led to convictions, and others sunk under the weight of lawsuits and lawyer fees because the rules were ambiguous. In many cases, officials could still plausibly declare that the expressed goals, social or economic, were achieved, but the nagging questions often remained. Throughout my career, I was eager to audit difficult topics. I succeeded with some, and learned the perils of the others. Lack of certitude is the fundamental deficiency in most audits of economic development programs. If you are comfortable with that, audit on.
