Opportunities for Improvement: Perilous Audits of Economic Development Programs
By Gary Blackmer
Beyond compliance testing, I concluded long ago that economic development audits have extremely high audit risks and only produce uncertain benefits.
Using corporate speak, the 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 percent success rate is the norm, but those 10 percent of businesses are so profitable that they make up for the 90 percent that are losers. It would seem that auditors would easily find economic development failures, but 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.
However, defining economic benefit is difficult. Is it more jobs? Increased property values? More business start-ups? Increase in tax revenues? Attracting more outside investors?
And how long does the public have to wait to see its benefits? How long must the dust settle on an industrial park, or 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 percent failure rate?
I am sorry that I am asking all these questions rather than answering them, but there are no definitive answers. In my experience, we asked the creators of these incentive packages to define success and 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 economists’ 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 geography you choose 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. 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 to see if there is a difference. Again, you face a challenge from those pesky economists who will say, “Oh, those incentives just attracted the jobs away from other areas you didn’t measure. You can’t conclude there was a positive overall benefit for the public.” 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. Those economists essentially posed the same “but-for” questions.
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. 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 alternative is 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 deserved decoration. Can we declare success when we find the program achieved those social goals, even when the economic ones are iffy? Sorry, 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 downtown. 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, they would discount them. They will 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 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, 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 are discouraging these types of audits but we should be good stewards of our own audit resources, producing the greatest benefits for the public, as we want other agencies to be with theirs.
I started by setting aside compliance testing of economic incentives because it is easier to audit, but challenging in a different way. A government often sets expectations when it grants economic incentives to boost a business area or a particular sector of the economy. There is a greater likelihood that some activities will be out of compliance with rules and regulations, and knowing that, will make it an easy audit to conduct.
However, the rules and expectations 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 their success, so they focus on cost, timeliness, and quality of their work. Of course we also have those 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, which are accessible to auditors, to reporters, and to the curious citizen. 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 particular 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. There are risks that a whistleblower 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. If you started an audit and that whistleblower contacted your office, what would you do? Just a hypothetical question of course. Declaring the topics are outside the scope of your audit seems the best idea, but only until the whistleblower contacts the reporter who calls you to ask why you ignored the serious allegations.
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 navigate the red tape, or 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. Government Auditing 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 a number of 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 and 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.
About the Author
Gary Blackmer has been conducting audits for 30 years and recently retired from his position as Director of the Oregon Audits Division. The Division conducts performance, financial, and information technology audits, monitors financial audits of local governments, and responds to hotline allegations. Previously, Blackmer served 10 years as the elected Portland City Auditor, eight years as elected Multnomah County Auditor, a management auditor, and analyst for a variety of state and local agencies. Blackmer is a past-Chair of the Pacific Northwest Intergovernmental Audit Forum, and past-President of the Association of Local Government Auditors. He received the ALGA Lifetime Achievement Award in 2015.