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At Congressional hearing, criticism of Yankees deal and stadium funding; IRS says final regulation coming soon

Piling on to Assemblyman Richard Brodsky’s report on the new Yankee Stadium, Rep. Dennis Kucinich (D-OH) said yesterday that his Subcommittee’s “still ongoing investigation has uncovered substantial evidence of improprieties and possible fraud” by the stadium’s financial architects.

Kucinich chairs the Domestic Policy Subcommittee of the Oversight and Government Reform Committee, which yesterday held a hearing to which representatives of the Yankees and the city of New York were conspicuously absent, though they are expected to appear in the future.

Though the hearing, “Gaming the Tax Code: Public Subsidies, Private Profits, and Big League Sports in New York,” focused on Yankee Stadium, the issues raised have direct applicability to the planned Atlantic Yards arena.

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 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.

Moreover, the new ballparks for the Yankees and Mets rely on special Internal Revenue Service rulings that allowed fixed PILOTs that conform to bond payments, while the IRS has proposed changing the rule to make sure that PILOTs fluctuate with taxes--anathema to the bond market.

That rule, expected to be finalized soon, has city officials nervous. Indeed, according to Metro, the city yesterday issued a statement that “complained of the new hurdles” to financing other projects similarly, such as Atlantic Yards. Whether Atlantic Yards might be grandfathered in under the old rules, as the city and state have sought, remains unclear, but the benefit to Forest City Ratner would be significant; I’ve estimated $165 million on $800 million of tax-exempt bonds.

(The city's statement: [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. It would not create thousands of permanent unionized jobs, just construction jobs. Tax-exempt financing for the arena is not required to create affordable housing.)

Other warnings

At the hearing, an economist pointed out leaps in ticket prices engendered by the new Yankee Stadium and warned that economic impact projections for sports facilities should be taken with a grain of salt. He also cautioned about overstating an increase in construction jobs, given that available subsidies could be redeployed for other projects.

Also, a law professor 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.

Did public pay for arena?

The New York City Industrial Development Authority yesterday offered a detailed rebuttal to Brodsky’s charges regarding the assessments. There's 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, but before and after project, the City will be collecting exactly the same amount in real estate taxes from the Yankees, the rebuttal noted. (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, but the Yankees have said that without the tax exemption, they would not have done the project, according to the rebuttal, so bonds for a new stadium would never have been issued on a taxable basis.

(My sources for this article are the written statements submitted by witnesses, plus some press coverage. The hearing was webcast in real time, but no webcast was available in the evening when I accessed the hearing web site.)

Kucinich’s criticisms

It was the third hearing in a year-and-a-half Kucinich’s subcommittee has held regarding sports facilities. In his opening statement, Kucinich reiterated criticisms established earlier: “[B]uilding sports stadiums does not make sense as a tool of taxpayer-subsidized economic development” and state and local governments “compete with each other to lure or retain professional sports teams in a senseless race to the bottom for larger public subsidies subsidized by the federal taxpayer.”

While support for needed infrastructure is neglected, taxpayers subsidize stadiums that are essentially private, he said, and taxpayer subsidies for sports stadiums represent “a transfer of wealth from the many to the wealthy.”

Kucinich cited “wildly divergent valuations for the land under the stadium... submitted by City and State government officials to the federal government.” He said that the Subcommittee’s consultation with experts led to the “provisional judgment” that the lower appraisal was more reasonable--and thus would’ve supported PILOTs for much lower bonds.

[The city said: Referenced valuations looked at land for different purposes and so had different assumptions (e.g., not all assumed completion of $1+ BN stadium; not all assumed $200+ MM of public infrastructure).]

Kucinich said that the tax-exemption on $940 million in tax-exempt bonds “will save the Yankees well over $100 million in interest costs” and “cost federal taxpayers almost $200 million in lost tax revenues.” While New York City has requested that the IRS approve more than $360 million in bonds for the Yankees, Kucinich said “these bonds should not be approved without further investigation.”

Though I don’t know if they discussed the Atlantic Yards arena, the implication of Kucinich’s remarks is that no arena bonds should be approved for now. Indeed, Brodsky called for the end of tax subsidies for stadiums.

Stadium valuation grows?

Kucinich also cast doubt on the city’s projected claims of future value: “Typically sports stadiums lose some of their value over time as they become obsolete, a process that usually lasts less than 40 years. But the City makes the highly suspect claim that the stadium never depreciates. Rather, they assert that it gains three percent in value a year through 2046.”

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. However, a proper assessment would’ve led to either a smaller stadium or larger contribution by the Yankees.

New hearing(s) coming

Kucinich said representatives of the New York Yankees and the New York City Industrial Development Agency were unavailable, but will appear later; the Yankees will testify October 7.

“The assessment issues are complex, and our inquiry is incomplete, in large part because the Yankees and the City have repeatedly failed to comply with our requests to produce documents about the assessments,” he said.

IRS testimony

Stephen Larson, Associate Chief Counsel, Financial Institutions and Products for the Internal Revenue Service (IRS), described the difficulty in deciding whether a customized PILOT deal more resembles “a generally applicable tax” or “more like a lease, rent or other payment” impermissible under IRS rules: “This line becomes particularly difficult to draw when the tax is abated through negotiations or is a PILOT that is crafted for the transaction and essentially results in debt service being fully paid by the private business.

Without referring to the Yankees and Mets by name, Larson noted that in July 2006, the IRS Office of Chief Counsel issued two favorable Private Letter Rulings (PLRs) on tax-exempt governmental bond financings for stadiums. While the IRS concluded that existing Treasury Regulations supported a favorable response--Kucinich disagrees--the PLRs “served to focus our attention on how broadly the existing regulations could be interpreted to permit PILOTs to be used to pay debt service on tax-exempt bonds in situations where the PILOTs bear an insufficient link to the otherwise generally applicable tax, and in fact closely resemble the expected debt service on the bonds.”

Thus, 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.”

Regulation coming soon

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 those “appropriate modifications” are remains unclear, but New York City and New York State have asked that requests for additional funding for the Yankees and Mets stadiums to be grandfathered in, along with the plan for tax-exempt bonds for the Atlantic Yards arena.

"The private letter ruling is only valid to the extent that it was based on factual recitations," Larson said, according to the Bond Buyer. "If the audit team were to determine that the underlying representations were false, then the PLR would essentially no longer be effective and the audit team would pursue its normal recourse."

Brodsky testimony

In his testimony, Brodsky addressed the national policy issue. "There is a growing national consensus that public financing of private sports facilities serves no useful public interest," he said. "The evidence we uncovered with respect to the Stadium deal is that there is little, if any, economic benefit to the public resulting from taxpayer subsidies. At a time when we are unable to fund our most basic infrastructure needs, the subsidization of sports facilities is not in the public interest and should cease."

Two wrongs make a right?

Brodsky allowed, as he did at the July 2 hearing he held, that there’s an argument for reciprocal unfairness, given that New York State gets more than $80 billion less than what taxpayers send to Washington.

"The only reason for the Stadium deal that stands scrutiny is that any arrangement that returns tax dollars to New York remedies the unfairness of the current system," he said. "The fact that these public dollars flow to the Yankees, a private, hugely successful and wealthy corporation not located in New York is a disturbing fact, but I must in fairness note the interests of my state in a fairer distribution of federal money."

Brodsky: bad policy

Brodsky offered a fundamental criticism of tax-exempt bonding: "There is a fundamental flaw in the decision by the Congress to allow for tax-exemptions that benefit private persons. The most obvious consequence of this policy is to create an economic development model that creates little new economic activity on a national basis. You have created a system that pits one state against another, that is marked by the elegant blackmail of private interests who receive subsidies and tax breaks not because of new investment, but because they threaten to leave one state for another.:

He concluded, "The Congress should stop the madness and restore fairness and equity to our tax system by denying tax-exemptions whose purpose is to move economic activity from one state to another." While Brodsky has not fundamentally criticized the Atlantic Yards project, his call to deny such tax exemptions would scotch the arena funding plan.

Indeed, the arena would bring new revenues to New York City and New York State mainly because it would shift economic activity from New Jersey, the current home of the Nets, according to the Independent Budget Office.

A law professor’s analysis

In his testimony, Clayton P. Gillette of the New York University School of Law aimed to define “ the proper scope of the federal tax exemption.” He noted, “there is a substantial argument that the tax exemption constitutes an inefficient subsidy,” given that it costs the federal government more in forgone income than it returns to states and cities in terms of reduced borrowing costs.

Such “potential inefficiency” is an argument for properly defining the scope of the exemption, he said. He challenged the claim that denial of the tax exemption interferes with local decisions about which capital projects to pursue; after all, states and localities can pursue projects without tax exemptions. They’d just have to pay the full market cost. Given that nonresident federal taxpayers receive no benefit from the project, the justification of the subsidy is unclear.

In fact, he added, an economic perspective argues that the locality should “bear the full costs of the project, so that local officials have an incentive to balance the purported benefits of the project against its costs and to induce local residents to ensure that their tax dollars are being spent in a manner consistent with their preferences.”

When’s a subsidy OK?

He suggested two circumstances under which such a subsidy is appropriate. One case involves projects undertaken by states and localities “that have positive external effects,” for example a project that could reduce pollution in multiple jurisdictions.

The second category, he said, is “a bit more nebulous, and arguably broader,” since it involves “projects that enhance the local autonomy of local governments generally,” giving them the latitude to experiment regarding “the best mix of publicly provided goods and services.” Also, he said, “Autonomous local governments also confer broader social benefits by acting in a manner that attracts a tax base that they believe will help enrich their communities.”

“Thus,” he observed, “federal subsidies are appropriate to ensure that localities possess the basic infrastructure and capital capacity that is a prerequisite to more productive local government.”

Sports facilities

“For instance, if a locality truly believes that a sports stadium will provide it with a competitive advantage or enhance residents’ sense of community, it may use the federal tax exemption to pursue that vision,” he said, adding that “federal tax law contains a variety of provisions that can properly be understood as imposing on a locality the obligation to ensure that the decision to undertake a project does, in fact, reflect the preferences of local residents.”

If the project aims solely “to satisfy the interests of a relatively small group of constituents,” then it doesn’t foster local autonomy, undermining the argument for federal subsidies.

“The availability of the tax exemption under those conditions looks more like an effort by which local officials can simply confer a significant benefit on favored interests in the form of lower financing costs, and shift the lion’s share of the subsidy to federal rather than to state and local taxpayers,” he said. “From the perspective of local officials, this is a winning strategy. They can confer an advantage onto local interest groups, but externalize the related costs in a manner that saves them from having to increase taxes or charges on their constituents.”

So the issuance of tax-exempt bonds, he said, should be linked to transparency and democratic accountability, helping ensure that subsidized projects will foster local autonomy and generate significant spillovers.

“To continue my example of the locally desired stadium, the locality may take advantage of the federal subsidy if it is willing to finance a stadium from municipal revenues that have been generated by the traditional taxing mechanism used by the city to fund the public goods and services that it provides – what are referred to in Treasury Department regulations as ‘generally applicable taxes,’” he said.

The point is that, if taxpayers are willing to pay for it, then it’s more likely “consistent with the ideal mix of goods and services that define local autonomy,” he said.

What about PILOTs?

He essentially expressed support for the proposed IRS amendments: “[T]o the extent that specific PILOT payments are dedicated to debt service for a particular project, those payments arguably have more in common with the kind of special charge, such as an assessment related to a particular municipal improvement, that the regulations exclude from “generally applicable taxes” used for general governmental purposes,” he said.

Because PILOTs don’t fit well with the issues of transparency and democratic accountability supposed to apply to generally applicable taxes--they don’t show up on governmental budget lines--”PILOTs appear to bear greater resemblance to the exactions that fall within the scope of private payments than to taxes,” he said.

The NYC conundrum

Gillette pointed to the efforts by the city to have it both ways. On the one hand, PILOTs are presented as substitutes for taxes. On the other, "the Mayor of New York City has taken the position that PILOTs constitute contractual rights that had been negotiated by the city rather than tax payments. As such, the Mayor’s Office has claimed that PILOTs were not revenues of the City susceptible to payment into the general fund and control by the City Council; instead, they were assignable to City projects within the discretion of the Mayor.”

“[A]t least to the extent that PILOTs are treated differently from taxes, they permit evasion of the kinds of democratic scrutiny that ensure that federally tax-exempt projects and financing structures reflect constituent preferences and serve the objectives of local autonomy,” Gillette warned.

That doesn’t mean the use of PILOTs for local projects is illegitimate, he said. “But nothing about the fact that PILOTs are useful from a local perspective requires that the federal government similarly embrace the concept,” he added. “Indeed, it is plausible that by disadvantaging opacity in public finance, federal tax law can provide useful incentives for the reform of anachronistic procedures in state and local finance.”

Consequence of change

Gillette, according to the Bond Buyer, said that if the IRS invalidated the PLR based on the allegations that have surfaced, the agency could declare the bonds taxable.

"Then bond holders who purchased them on the belief that the interest they received would be tax exempt are going to be, shall we say mildly upset," Gillette said. "The city would have to step up to avoid imposing additional tax liability on the bondholders."

Ticket prices going up

Brad R. Humphreys, Associate Professor, Department of Economics, University of Alberta, and a critic of sports facility deals, offered some context: “the financing of both new baseball stadiums in New York City was influenced by threats made by both the New York Yankees and New York Mets to leave the city of New York.”

In his testimony, he said that teams benefited from the anti-trust exemption that limits the number of Major League Baseball (MLB) franchises and gives them bargaining power. “The ultimate cause of the New York PILOT mess is MLB’s anti-trust exemption,” he said.

The lack of competition means teams have “significant latitude when setting prices.” Indeed, the new Yankee Stadium will lead to a “139% annual change in the average price of a Yankees ticket, and a stunning 669% annual increase in the price of the highest ticket price offered. No MLB team moving into a new stadium has increased the top ticket price offered by this amount in the past 33 years.”

(Note that Nets ticket prices also would leap some 73%, according to one set of documents.)

He suggested that the “access to lower interest rates offered by tax exempt funding, coupled with the lack of budgetary-related limits on costs combine to produce the most expensive stadium construction project in the history of Major League Baseball,” and the lavish stadium enables the Yankees “to pass on extraordinary ticket price increases to their fans.”

Economic impacts

Humphreys also scoffed at claims of significant economic benefits from sports stadium construction and operation. “First, they are forecasts, and not actual counts of jobs created or income earned,” he said. “In the PILOT issue, and every other sports facility construction project I have studied, these forecasts of economic benefits are treated as factual assessments, rather than the forecasts that they are... Any additional claims of future economic benefits from the project should be taken with a grain of salt."

Construction jobs

He also suggested skepticism regarding claimed benefits from the construction jobs. “The key to determining the actual net economic benefits generated by sports stadium construction projects is to determine how many jobs are created that would not have existed if the project did not take place, and also to determine how many of the workers filling those jobs would have been unemployed if the project had not taken place,” he said. “According to economic theory, only this small subset of the total number of jobs created by a stadium construction project can be counted as part of the economic impact of the project.”

“The net economic benefit created by stadium construction projects is much smaller than the total economic benefit (which can be easily found by simply adding up the total amount of spending associated with the project) because of the presence of opportunity costs, and the double counting that typically takes place when non-economists attempt to estimate these benefits,” he observed.

“Opportunity cost is the cost of forgone alternatives. In the case of the New Yankee Stadium, the facility generates significant opportunity costs for the City of New York and in the local community," he said. "The City could have issued a billion plus dollars of tax exempt bonds to finance any number of alternatives.”

“The materials and supplies that are going into the construction of the new stadium could have been used on other construction projects,” he said. “And most importantly, the construction workers employed on this project could have worked on other projects.”

Similarly, that’s been one argument regarding Atlantic Yards--while supporters often suggest it’s AY or nothing, others point out that an alternative, albeit smaller project, could be built on the Vanderbilt Yard, and subsidies and incentives deployed elsewhere.