Key Reforms: Clawbacks

Reform #2: Clawbacks, or Money-Back Guarantees

A clawback, or recapture provision, is a clause of a subsidy law or contract that simply says that a company must uphold its end of the bargain or else taxpayers have some money-back protection.

How clawbacks work

When a company signs a subsidy deal, it typically promises to deliver a set of public benefits. For example, a company may state on its subsidy application that it will invest $1 million in a new plant projected to employ 100 people full time at $20 per hour. If that company fails to follow through on the investment, number of jobs, employment hours, or wage rate in a specified amount of time, and the subsidy deal has a clawback provision, the company must forfeit or repay all or part of its subsidies to the state or local government that awarded them.

Many clawback laws are written so that different penalties apply depending on how badly a company fails to meet its targets. A clawback may prorate a subsidy; for example, if the company falls 10 percent short of its goal, it has to pay back 10 percent of the subsidy. A steeper penalty may apply if the company falls far short. If a company shuts down or moves out of state, the government may require it to pay back the full amount of the subsidy, with interest.

Clawbacks are added to development subsidy programs through the legislative process at the state and/or local level. They are also included as a provision of subsidy contracts negotiated and signed by governments and developers.

Why we need clawbacks

Clawbacks provide taxpayers a way of making sure their investment in development subsidies pays off in the form of real public benefits, and allow governments to recoup their money if it does not.

The concept of a clawback may seem like common sense. However, with the way many subsidy deals are currently structured, companies often face no penalties if they fail to deliver on promised jobs or investment. A company’s plan to create public benefits may be regarded by both corporate executives and public officials as more of a goal than an enforceable commitment. Governments often take a “good faith” approach, assuming the company has done and will continue to do its best, and letting it off the hook if it falls short.

The result of such lax enforcement is that taxpayers end up subsidizing companies for things they don’t do. In most cases, the failure of a company to live up to the terms of the subsidy means that it creates fewer jobs, or jobs of lower quality, than promised. In some cases, subsidies have gone to companies that later eliminated jobs, closed up shop entirely, or moved to other states, literally taking the money and running.

Just as important as the money-back penalties in clawback laws are the requirements that companies and governments monitor the outcomes of subsidized projects. Neither companies nor public officials can typically boast a stellar record when it comes to tracking or reporting to the public how actual performance of subsidized projects measures up to expectations. Annual reports ensure that individual companies are complying with the terms of their agreements, and also allow states to evaluate whether subsidy programs are meeting their objectives overall. When this information is made available to the public, it is called disclosure data.

Money-Back Guarantees for Taxpayers

In January 2012 Good Jobs First released, Money-Back Guarantees for Taxpayers, a report about clawbacks as well as other penalty practices and the monitoring procedures used by state governments to determine whether a recipient is in compliance with program requirements. We examined a sample of 238 major subsidy programs in all 50 states and the District of Columbia, using a scoring system (covering both performance standards and enforcement) to grade them on a scale of 0 to 100. Here are our key findings:

Ninety percent (215 of 238) of the programs we examined require companies receiving subsidies to report to state government agencies on job creation or other outcomes. Yet in 67 (or 31 percent) of those 215 programs, an agency does not independently verify the reported data.

The 67 programs that require reporting but not verification are concentrated in 35 states, of which 19 have more than one program with that shortcoming. Remarkably, both the District of Columbia and South Carolina have no performance verification in any of their five major programs in our sample.
About three-quarters (178) of the programs we examined contain a penalty provision of some kind, including recapture of benefits already provided and the recalibration or termination of future subsidies. An additional 41 programs are “performance-based,” meaning that the company does not receive benefits until it has satisfied program requirements. This leaves 19 programs (or 8 percent) with little or no recourse against companies that fail to deliver on their job creation and other promises.

The penalty provisions in 84 of the 178 programs with penalties are weakened by the fact that their implementation is discretionary rather than mandatory or by the presence of various exceptions. Appendix 4 of the report has summaries of the penalty provisions used by the programs we examined.
We treat the disclosure of enforcement data as a prime indicator of whether an agency is serious about dealing with non-compliance. We find that: only 21 programs in a dozen states publish aggregate enforcement data (i.e., without company names or other deal specifics); only 38 programs disclose the names of companies deemed to be out of compliance; and only 14 disclose the names of companies which have been penalized (and the dollar amounts). See Appendix 5 of the report for the web addresses of enforcement disclosure sites.
The states with the highest average program scores are: Vermont (79), North Carolina (76), Nevada (74), Maryland (70), Iowa (69), Virginia (69), and Oklahoma (64). The states with the lowest averages are: the District of Columbia (4), Alaska (19), North Dakota (30), and South Dakota (34). Twenty-two states score above 49, which is the average for all the states.

To assist economic development policymakers and practitioners in improving their subsidy enforcement practices, we offered the following policy recommendations:

All recipients in all programs should be required to report to agencies on job creation, wages, benefits and other performance benchmarks. Recipient reporting data should be disclosed online at least annually as part of a state’s disclosure system.
All reported information should be verified by agencies using techniques such as auditing and cross-checking of company claims against separate reliable data sources such as unemployment insurance records.
Agencies should penalize recipients found to be out of compliance, employing techniques such as recapture (clawbacks), recalibration of future benefits and rescission/termination of subsidy agreements. Programs that are performance-based should operate without penalties only if recipients are required to fulfill all programs requirements before receiving any subsidies.
Penalty systems should be straightforward and consistent and not weakened by various exceptions or by giving agency officials discretion on whether to implement them.
Agencies should publish detailed data on their enforcement activities, including the names of the recipients found to be non-compliant and those penalized (including the penalty amounts).

Caveats

Many of the early clawback laws were passed by jurisdictions that were recently hurt by a subsidy gone awry. States and cities without clawback laws shouldn’t wait to be the next victim, but should proactively add clawbacks to their subsidy programs. Public officials are sometimes reluctant to enact clawbacks, citing concerns that such laws would send unfriendly signals to potential businesses and hurt the region’s “business climate.” But clawbacks should not be viewed as a threat to business. Rather, they are a tool that set out clear expectations for parties on both sides of the table, lessening the possibility that disagreements will escalate to lawsuits. If the rule is simple, fair,and evenly enforced, businesses will accept it.

Clawback language is a tool to protect taxpayers’ investment in subsidized companies, ensuring that companies deliver on their promises. But what are they promising? In addition to clawback provisions, development deals must incorporate strong standards as to the benefits subsidized companies are expected to create. Other key reforms, including job quality standards, get into this issue in more depth. Once those requirements are in place, public officials must monitor corporate performance on a regular basis, and enforce clawbacks when needed. Public participation is often key to holding both companies and public officials accountable to following through with the terms of subsidy agreements.