Draft

A rough introduction to

The Economics of Giveaways

by Doug Moran

Introduction

In my upcoming Guest Opinion in the Palo Alto Weekly on the City Council's decision on Alma Plaza, I used the controversial term "giveaway" because I couldn't find a better one. A giveaway is defined in terms of moneys that a government agency controls, and it is the measure of that control that is the underlying controversy.

Some people take a very narrow interpretation of "control," restricting it to only moneys that pass directly through that specific agency's budget. This typically comes down to subsidies where the agency hands over a check and to payments of taxes and fees that the agency agrees not to collect.

A more expansive approach to "control," includes financial transfers that the government agency causes to happen, but doesn't route through their budget.

The broadest level includes economic dislocations that the agency expects or intends to happen. Although the additional transfers included at this level are in essence just more complex versions of those at the previous level, but the quantification of the costs is difficult and routinely controversal, For example, how do you count sales tax that would have been received from a store that should have been built (but wasn't).

In discussing a giveaway, it is important to separate out disagreements over the facts about the components of the giveaway from disagreements over where the boundaries for "control" are.

Disclaimer: I am not an economist. I know enough economics to be able to identify components of a problem, but I don't know enough to be able to accurately quantify the various costs. This is an attempt to make accessible relevant portions of what I have learned on this topic. If you have better explanations or supplementary materials, please send me pointers.

Motivating example: The airport giveaway

In terms of being easily understood by a broad audience, the best example of how to assess this category of giveaway involves airports. I recognize that this description will be painfully long for many people, but that illustrates a basic lesson: these sort of giveaways are easy to slip by taxpayers because explaining the various components can be quite difficult.

Airport traditionally have been surrounded by buffer zones to accommodate the noise and safety issues, and to have uses that can reasonably be reclaimed when the airport needs to grow. And just as routinely, these buffer zones have been targeted by developers with political muscle: The developer buys the land at the low price of its legitimate use, then gets it rezoned for a use with much higher returns, such as housing.

People who take a very constricted view of what constitutes a giveaway say that there has been none, and that the difference between what the developer paid for the land and what it is now worth "appeared through the magic of markets." But let's take a look at the costs of some of the very predictable events triggered by this zoning conversion.

Soundproofing: The owners of the new housing routinely sue the airport about the noise, and airports routinely pay. Friends in Carlsbad report this very situation there: The lawsuit filed shortly after the first houses were sold, while much of the development was still being built. Since the airport is a government agency, some of the settlement costs come directly from taxes and some come from fees on airport users.

People taking the narrowest view will say that no giveaway occurred because the airport is not the same government agency as the one that granted the zoning change. People who view government in terms of citizens and taxpayers, rather than politicians and special interests, reject this distinction as meaningless.

Because the lawsuit is likely to be successful, the developer can include much of the settlement in the selling price. But some of the giveaway goes to the homeowners for assuming the risks and costs of the lawsuit. This giveaway is actually split between the developer and the homeowner.

Reduced safety margins: These lawsuits often force the airport to change its operation to make noise issues a larger factor. To reduce and reshape the noise "footprint" the airport requires planes to takeoff and land at steeper angles, and constrains the choice of appropriate runway. Pilots say that the takeoff is the most risky portion of a normal flight and that increasing the takeoff angle increases the risk of something going wrong (for example, an engine failing because it is being pushed to the limit) and reduces the ability to recover from a failure.

Suppose you were told that steeper takeoffs increased your risk of being killed in a plane crash by one-in-ten-million? What if you were told that it would result in an average increase of one death a year? Or that it would mean a 10% chance of a plane crash killing 100 people sometime during the next ten years? For an airport handling 10 million departures a year these are all statistically identical, but psychologically very different. (Takeoff comparisons: SFO has about 17 million; San Jose, 5.5). People in general have great difficulty dealing with low-probability/high-cost events. Some will choose to ignore it: One-in-ten-million is too small to worry about. Others will look at the 10 percent chance and argue to do nothing with the hope that the crash doesn't happen (their real reasoning may be the hope that the crash doesn't happen until after they have moved on and coping with it is someone else's problem).

Other costs: The discussions of steeper takeoffs state that they use significantly more fuel - increasing pollution and costs (to the passenger). Reducing the noise "footprint" can entail limiting the number of flights, the hours of operation, and even what planes can use the airport. Part of the role of the airport buffer was a reserve for future growth, but that is now precluded because of the conversion to housing.

Summary: Although the rezoning of land in the airport's buffer is directly and causally tied to the diminishment of the economic utility of the airport - a valuable public asset - some will argue that no giveaway has occurred because it is impossible to take a dollar bill associated with any of the many public losses and trace it directly to the developer bank account. To me, this is no different than the argument that smoking doesn't cause cancer.

Poor conceptualization of low-probability/high-cost events

There has been extensive study by psychologists and economists about how people perceive and respond to risks, and the basic conclusion is that people do a poor job, both wildly overestimating some and wildly underestimating others. As a corollary, they are very bad at fiscalizing those risks.

In the 1990's I was heavily involved in a flood control project here in Palo Alto (Matadero and Barron Creeks). The economists had chosen protection from the "100-year flood" as the standard - For their normal situation, it represented the balancing point between the costs of protection and the costs of flood damage. They discovered they had a terminology problem. This is a flood that occurs statistically every hundred years when averaged over the millenia. But people interpreted the phrase as meaning that there were 100 years between these floods and that the next one was far in the future. The equivalent term "one percent flood" (one percent chance of happening in any given year) also failed because many people judged the probability to be too small, thinking of each year in isolation, rather than cumulative risk.

I had grown up in an area which had had two 100-year floods, a 500-year flood and a 1000-year flood within a 25-year period, so I understood the "ground truth" under the statistics (big floods often occur in clusters, separated by long quiet periods), whereas many of my colleagues had been mislead by the over-simplified statistics into a very different model of the threats of flooding.

Backdoor transfers - inefficient and costly

In many ways, the public would be better served if the politicians, once they decided that they were going to give millions of public money to private individuals, simply cut a check rather than using backdoor transfers. Backdoor transfers are expensive for many reasons:

Way back when I took economics in college, the textbooks mentioned the problems of corruption, favoritism, and other non-transparent transactions, but they didn't give any feel for the tremendous impact. A talk I heard heard several years ago about the collapse of the Soviet Union was eye-opening. The speaker speculated that the corruption of the political system did more damage to the Soviet economy than Communist economic theory, and provided several examples where economic decision-making had been driven by how much could be stolen. An example from agriculture went something like this: The crop that would be chosen on a rational basis for a farm might generate $1 million, of which the official could steal only one percent, of which he would lose 50% converting from the local currency to a hard currency, leaving him only $5000. However, if he had the farm grow a crop for the export market that was worth only $50,000, but which would allow the official to skim off 20% in hard currency (avoid the conversion loss), he would bank double that for reducing the value of the farm's crop by 95%.

Going back to our airport example, retrofitting new houses with additional soundproofing is horribly inefficient: It is more expensive and less effective than if it had been done when the house was being built. Add to that the cost of the lawsuit. Because our example city only created a situation that forced the airport agency to hand over money, rather than the city handing over money itself, some will argue that no giveaway occurred.

A response to the very restrictive notion of "giveaway"

The very restrictive notion of a "giveaway" applies to only two cases:

A simple analogy demonstrated the sophistry of this thinking. Suppose someone surreptitiously clones your cell phone and makes thousands of dollars worth of calls that are billed to you. The cloner has not stolen from the phone company because it has been paid for the calls (by you), and he has not stolen from you because you paid for the calls after he used the service, therefore no money was transferred from you to him. Yeah, right.

Giveaways to developers as side-effect

Palo Alto has a zoning category of "Planned Community" (PC) which was created for projects that are so exceptional that the overall community would suffer if the normal zoning were applied. However, in actual practice, the PC is used to cover giveaways.

Scenario: A group is having problems getting its special interest funded from the City budget, so they maneuver to get it funded indirectly by having a developer include it in his project (public art is a common example of this). You combine one or two Council members who are influenced by this special interest group with the Council members who are philosophically inclined to support giveaways to developers and add in a Council member or two who doesn't see the value in fighting the giveaway, and you have a Council majority.

Notice that for the Council members responding to the special interest group, the lucrative concessions made to the developer are not giveaways, but rather a (huge) fee paid to launder the money for the special interest project. Every now and then a Council member will attempt to get values assigned to various components of a deal, but gets no support from the Council. Consequently, we don't know if the City even managed to get cents-on-the-dollar for these concessions.


Alma Plaza - the giveaway

The $12 million I cited in my Guest Opinion is the difference between what the developer paid for the property (public records) and the lowest estimate of what he could sell the property for immediately after it was rezoned. I did not include any profits that could reasonably be expected from normal business activity such as the development of the property. The $12 million is the calculated return on the exercise of political clout, not business acumen, hard work, or risk-taking.

Based upon discussions about the economics of this and similar projects, here are some of the sources of the money being transferred by the backdoor to the developer:

I am not going to waste your time (and mine) trying to explain this particular giveaway further because I haven't found a way that works. People who found the airport example interesting told me that my explanation of the Alma Plaza giveaway involved too many boring details.