Saturday, September 20, 2008

A second look at the Kucinich hearing, the Yankee Stadium controversy, and the future of the Atlantic Yards arena

It's worth a second look at some of the charges and countercharges that emerged Thursday in response to Assemblyman Richard Brodsky’s report on the new Yankee Stadium and the hearing held by Rep. Dennis Kucinich (D-OH), chair of the Domestic Policy Subcommittee of the Oversight and Government Reform Committee, called “Gaming the Tax Code: Public Subsidies, Private Profits, and Big League Sports in New York”. (Hearing video is now available.)

What are the hurdles for Atlantic Yards?

1) Investigators from the committees headed by both Brodsky and Kucinich have concluded, at least on an interim basis, that city officials "gamed" the tax assessment for the new Yankee Stadium so it would be high enough to justify the amount of tax-exempt bonds requested by the team. If similar shenanigans were found regarding the Atlantic Yards arena, tax-exempt bonds might be scotched, costing the developer perhaps $165 million.

2) Even if no such subterfuge is found, the arena is still jeopardized by a proposed Internal Revenue Service (IRS) rule that would require that PILOTs (payments in lieu of taxes) fluctuate so they look like generally applicable taxes, rather than fixed so they look like bond payments. The city and state have lobbied hard to get the arena--as well as additional financing for the Yankees and Mets--grandfathered in. Develop Don't Destroy Brooklyn disagrees.

The New York Observer notes that the controversy "comes as the I.R.S. in a waning Bush administration weighs the request by the city and state to allow the use of their financing structure for the Nets arena." Perhaps, as with the approval of Atlantic Yards in the last days of the Pataki gubernatorial administration, project backers are wary of a change of leadership.

Is Kucinich's committee done?

Not in the slightest. Kucinich asked Brodsky how New York City Department of Finance came up with the $275 per square foot amount assessment for Yankee Stadium and who actually did the assessment.

"After reviewing documents, we met directly with Department of Finance personnel. The seven elements of this assessment are listed in my direct testimony," said Brodsky (right). "When we raised with them, the question of why they didn’t take comparables in the Bronx, why they took them in Manhattan, when we raised with them why they didn’t adjust for lot size, they literally fell silent."

Brodsky pointed out that, two blocks from the stadium, the developer of the Bronx Terminal Market, which has an interest in lower per square foot land value, found it calculated at $9 psf.

Kucinich commented, "In this particular case, the disparity between $275 per square foot and $45 per square foot requires this subcommittee to not rest until the silence is broken."

Do those who testify before Kucinich's subcommittee testify under oath?

Yes. Officials from the city and Yankees are expected to testify at a future hearing.

Will the IRS investigate the apparent effort to "game" the assessment for the Yankees?

Maybe. IRS lawyer Stephen Larson said that his department does not audit requests for private letter rulings (PLRs), which the Yankees and Mets obtained, but all information is submitted under penalties of perjury.

He said he could not discuss any specific cases, but "the IRS does read the papers."

What are the consequences if the assessment of Yankee Stadium was improperly inflated?

"We’re speaking hypothetically, but there could be extraordinarily serious consequences for the city of New York," commented NYU law professor Clayton Gillette. "The IRS would have the ability to declare bonds taxable. If those bonds were in fact taxable, then bondholders who purchased them on the belief that the interest was tax-exempt will be, shall I say, mildly upset."

The city would have to pay the lost revenue--perhaps $200 million--to the feds to avoid imposing additional tax liability on the bondholders, who might file claims against the city. "If there have been knowing misrepresentations, then I take it, the city, along with other participants in the bond process, would be subject to liability."

Was the Yankees' threat to leave New York City--the ostensible justification for tax-exempt bonds--credible?

"The evidence we uncovered shows that such a threat was not made and when asked, under oath, the head of the IDA [Industrial Development Authority, Seth Pinsky] sort of conceded that he didn’t know if, when and how such a threat was made," Brodsky testified. "To the extent that it was in the ether, in the background, and was something that the city had to sort of be worried about, without an explicit threat--well, it seems to me, when you’re negotiating a billion dollars worth of goodies, you ought to have more than the ether. Second of all, for that to be a real threat, there had to be a place for them to go... Were they going to go to Jersey? They had said publicly they would not do that."

"Now, you’re playing chicken a little bit here," he added, "because no leader of the city of New York wants to be the public person responsible for ‘losing China’--I mean, losing the Yankees--and in that case, I would simply suggest that there was a public process to test it, they had an obligation to tell the truth, and they did not."

Can Atlantic Yards developers get arena bonds?

PILOTs (payments in lieu of taxes) can’t exceed the amount of foregone taxes, but PILOTs for the Yankee Stadium were based on an assessment inflated aimed to justify a certain quantity of bonds, Brodsky and Kucinich charged. The same tactic might be in store for Brooklyn, given that the expected arena PILOTs far exceed the foregone taxes for the comparable Madison Square Garden.

Also, NYU law professor Clayton Gillette suggested that tax-exempt financing for sports facilities, given that it’s not subject to transparency and local democratic oversight, should be looked at skeptically by the federal government.

Still, that's not to say the arena wouldn't be grandfathered in--or perhaps we should start calling it, in an echo of the 421-a "carve out," the "IRS carve-out."

Is a compromise possible?

Sure. A lower assessment than currently expected regarding the AY arena would mean lower foregone taxes, which would limit the amount of tax-exempt bonds. But that still might be enough to build the arena--perhaps one with fewer bells and whistles, at a lower cost.

What about the credit crunch? What about suites?

It might make it harder to sell the bonds, but it certainly wouldn't scotch the deal. Another factor is that the meltdown on Wall Street is going to make it harder to sell the luxury suites the developer hopes will pay off the bonds, as the New York Post reported yesterday.

The Post said "roughly 30%" of the Atlantic Yards arena suites have been sold. That's all according to Nets brass, so take it with a grain of salt.

Does the public really pay for construction?

Well, if you consider that the developer doesn't have to pay real estate taxes--but it depends on which public. The New York City Industrial Development Authority, in its detailed rebuttal to Brodsky’s charges, expressed a fundamental disagreement on whether a benefit to the Yankees is also a cost to local taxpayers.

Brodsky says the use of PILOTs to pay bonds is a cost to the city because it doesn't collect real estate taxes. However, the NYC IDA points out that, before and after project, the city will be collecting exactly the same amount in real estate taxes from the Yankees. (The Independent Budget Office has similarly not counted it as a loss.)

Brodsky counts lost income tax on tax-exempt bonds as a cost of project. However, the Yankees have said that without the tax exemption, they would not have done the project, according to the city's rebuttal, so bonds for a new stadium would never have been issued on a taxable basis. The city says that PILOTs aren't taxes. Then again, as Brodsky points out, to the IRS they said PILOTs were taxes.

"What this needs is a forensic accountant and somone who wants to apply the law fairly to everybody," Brodsky testified Thursday. "I didn’t get any pleasure out of this mess. But the fact of it is when you examine the details of the economic and legal relationships, they stink."

What about the arena?

The same rationale applies to the arena, but... Forest City Ratner chief Bruce Ratner has said casually that the developer will do the project no matter what happens to the regulations. A spokesman also said the developer was confident about obtaining taxable financing.

Now that doesn't mean a commitment to taxable financing for the entire arena, just the portion--perhaps $150 million of the $950 million tab?--not covered by the tax-exempt financing. Still, it's worth a further look. If the developer could build the arena without tax-exempt financing, then the benefit to Forest City Ratner could be considered a cost to taxpayers.

Who wins, who loses?

A tax-exempt financing deal sounds like magic--it's no cost to the city, but it's a benefit to the Yankees and, the city would argue, to the city coffers and the city at large.

The losers are federal taxpayers, as pointed at the hearing Thursday. Then again, as even Brodsky acknowledged, there's a backhanded argument for such subsidies, given that New York State, unlike most states, contributes more to Washington in tax revenue than it receives.

Then again, the main beneficiaries would be the Yankees, not the public, according to Brodsky. The same could be said to apply to Forest City Ratner regarding Atlantic Yards.

What's the test for lawmakers?

If federal taxpayers are the losers, what in general should lawmakers consider in regulating tax-exempt financing?

As Gillette testified Thursday, "[T]he tax exemption should be tied to fostering democratic accountability and financial transparency at the local level. The use of PILOTs, at least as structured in the Yankee Stadium deal, does not readily meet that test."

Could arena valuation increase?

Kucinich noted that sports stadiums typically lose some of their value over time as they become obsolete, but "the City makes the highly suspect claim that the stadium never depreciates."

The inflated assessment thus allows the City to claim that the payments that will be made by the Yankees for debt service fit the IRS rules for PILOTs.

We should keep watch for a similar claim regarding the Atlantic Yards arena. As author Neil deMause has noted, major changes in sports facilities are usually requested by their second decade.

What exactly is Atlantic Yards?

The city said: [Brodsky's'] new efforts, though, may create hurdles for other economic development projects, including, for example, Atlantic Yards in Brooklyn - a $4 BN project expected to create thousands of unionized jobs and 2,000+ units of affordable housing.

Note how the city focuses on the most politically palatable elements. Atlantic Yards would create relatively few new permanent jobs (I estimate fewer than 1500 in the first phase), with only a fraction unionized.

Atlantic Yards would bring thousands of temporary construction jobs, 1500 a year for a decade--or a smaller number per year over a longer period of time. As noted at the hearing, construction jobs could be created with an alternative use of subsidies.

While a denial of tax-exempt financing for the arena would make it harder to create Atlantic Yards, given that the design of the arena is integrated into the four towers around it, tax-exempt arena financing is not required to create affordable housing.

In fact, a significant amount of tax-exempt housing bonds--$1.4 billion--would be required for the affordable housing, and the city doesn't have the capacity to issue such bonds in the short-term, at least.

When will IRS issue its final rule on PILOTs?

Larson (right), Associate Chief Counsel, Financial Institutions and Products for the IRS, described how, after the "loophole" allowing the Yankees and Mets to proceed caught their attention, in October 2006, the Treasury Department and the IRS published Proposed Regulations to clarify and to tighten the standard, essentially eliminating “the ability of a State or local government to set PILOTs at fixed amounts that do not fluctuate with changes in the underlying taxes on which the PILOT is based.”

Larson noted that the IRS and Treasury Department have received numerous public comments on the Proposed Regulations and plan to issue final regulations "soon" on the treatment of PILOTs, with appropriate modifications based on the public comments received.

What are those “appropriate modifications”?

The city and state want to make sure the three New York sports facilities are grandfathered in.

Larson, in response to a question, gave at least a nod to those concerns. He testified that, in choosing an effective date for tax regulations, one consideration is that "we look at the expectations of people being affected."

Would the IRS proposed regulation for fluctuating PILOTs work in the bond market?

If PILOTs must track generally applicable taxes, and change as real estate assessments change, as is proposed, it might be very hard to sell the bonds. "We are certainly not experts in the marketing of bonds," Larson said. "That's why there was a public comment."

Stay tuned.

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