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The Problem With San Diego’s Business Subsidy Program

San Diego's business subsidy program is a mess. The city doesn't track it well, or have a good system of determining who deserves special assistance, and the benefits rarely go to the city's poorest communities.

Vons in Mission Hills / Photo by Adriana Heldiz

San Diego’s business subsidy program is a mess.

Since the early ‘90s, San Diego has tried to encourage economic growth by offering businesses cash incentives or help navigating the city’s bureaucracy.

But that program suffers from a lack of diligent record keeping, clear policing of whether businesses qualify, broad outreach to ensure subsidies are equitably distributed throughout the city and adequate analysis that the assistance offered actually encourages investment that wouldn’t otherwise occur, according to a report released this month by the city’s independent auditor Eduardo Luna.

A few years ago, the program garnered headlines when the city spent nearly $2 million helping Illumina, AleSmith and Ballast Point with expansions.

More often, the business and industry incentives program has been used for smaller businesses, and the subsidies aren’t always straight cash rebates. Instead, businesses benefit from staff time that isn’t available to every business, and the economic development department estimates the cost a typical business would have to pay to receive that attention.

For instance, in 2010 and 2011 the city gave Vons an estimated benefit of $57,000 in staff time spent securing building permits and evading development regulations. The community and city planners had eyed the property for a mixed-use project with affordable housing, but Vons threatened not to build its grocery store if it had to abide by those requirements. City staff helped them out.

Other businesses might wonder how they can tap into that sort of help. But the report found businesses in poor parts of town rarely get the same attention.

Timothy Bartik, a senior economist at the Upjohn Institute for Employment Research, has studied these sorts of subsidies for years and wrote a book on the topic in 1991.

Subsidizing retail projects, he said, rarely makes any sense.

“If you’re going to do incentives at all, it should be for export-based industries,” Bartik said. “Export industries bring new dollars in and have a multiplier effect that grows the economy.”

That’s because retail businesses succeed or fail based on how many people near them buy what they’re selling. Subsidizing a McDonald’s won’t create new jobs, because people near it are only going to buy so many cheeseburgers — the new McDonald’s just borrows demand from the Wendy’s across the block.

“The basic problem about subsidizing retail-oriented business is that you’re just redistributing jobs,” Bartik said.

He distinguishes between two types of subsidies.

One is for economic development: They grow the regional economy by adding jobs.

The other is better understood as community development. They won’t create jobs or grow the economy, but they may be worthwhile for other reasons. For instance, a city might want to subsidize a grocery store’s development in a neighborhood that doesn’t have any, even if it doesn’t create any jobs.

That’s closer to what the city did with the Vons in Mission Hills, but that brings up other problems.

Typically, you’d reserve those deals for low-income areas, or areas that need help for some other reason.

Mission Hills is not a poor neighborhood. Homes there go for twice the citywide median, as the auditor pointed out. It doesn’t lack grocery stores, either; there are five within a mile and a half of the Vons, including one across the street.

Yet that Vons was the only grocery store that got an incentive from the city during the five years studied, even though roughly 95 grocery stores tried to open. Forty of them were in zip codes considered “in need of development,” and half of those either didn’t open or have since closed.

“Why are they doing it? It’s probably because the company asked for it and the city didn’t want to say no — but there’s no clear rationale for it,” Bartick said.

That’s not far off. The city’s internal tracking system for permits showed how Vons got its subsidy.

City planners told Vons’ developers that the neighborhood’s community plan envisioned the property for dense, mixed-use development that should include things like office space or affordable housing.

The company didn’t like that sort of pressure from the city, and asked for help getting around the rules.

“Vons officials reached out to (the economic development department) and warned of the potential that Vons could withdraw the project including the $25 million capital investment due to the cost and difficulty related to the city’s requests,” the audit reads. “Vons requested assistance to avoid providing office or residential uses as part of the project, and also requested expedited permitting.”

In the end, the city spent some $57,000 worth of staff assistance that isn’t typically available to a business building a new location to help Vons get around those requirements.

Auditors called that expenditure “problematic for several reasons.”

Similarly, the city helped out a restaurant in Liberty Station — even though that area is also newly developed and includes roughly 30 restaurants.

The city’s director of economic development, Erik Caldwell, said he was generally appreciative of the audit and agreed with most of its recommendations.

One of his department’s top priorities for 2018, he said, was to have the City Council vote on a new Business and Industry Incentive Program to address the problems that auditor identified.

The existing policy “no longer reflects what economic development practitioners would say is the best practice,” Caldwell said.

He pushed back on one major area, though. Caldwell thinks the auditor should have distinguished between a business incentive and “good customer service.”

“From my perspective, we help all businesses,” he said. “If a business has an issue that is keeping them from growing or investing, and it’s in the purview of the city to assist, then we should help. That, to me, is not an incentive.”

Getting on the phone with development services and helping Vons get needed permits, he said, was just a matter of good customer service.

“It was a business in San Diego that came to us and wanted help, and we felt inclined to do that,” Caldwell said.

The concern with that sort of standard, though, is that not all businesses are equally likely to seek assistance. It raises the possibility those differences could systemically exclude certain types of business owners.

And the auditor’s report seems to have concluded that’s exactly what happened. The outreach that does exist, auditors said, was tilted towards people who already had relationships with people in city hall.

Out of the 200 businesses the department helped as part of the program in the last five years, none were in the southeastern portion of the city that is south of I-8, north of SR-54 and east of I-805.

Beneficiaries were instead clustered in the northern part of the city, near Sorrento Valley and University City, downtown or along the border. Biotech and craft breweries got a lot of help.

“We found that many businesses that likely meet program eligibility criteria are unaware of the (program), which limits its effectiveness,” the auditors wrote. “In addition, although the City Council intended the (program) to encourage development in older, underserved areas of the city, we found that, in many of these areas, very few businesses have received (program) incentives during” the five years examined.

Of the 200 business incentives awarded by the city of San Diego in the last five years, most went to the Sorrento Valley, downtown and border areas.

Caldwell said that’s just because businesses who need the help tend to be in a handful of neighborhoods. If you look at other programs his department offers, like the store-front improvement program, beneficiaries are more evenly distributed, and are commonly in low-income commercial districts.

Bartick said offering businesses help navigating city requirements is often a better idea than handing out cash. Expert assistance is often worth more to a small business than a comparable cash payment would be.

“It’s just a better bang for your buck than just cash,” he said. “It’s an in-kind subsidy, if you want, but ideally everyone should get good service from the city.”

But San Diego’s deals with Illumina, AleSmith and Ballast Point were lucrative cash subsidies.

Illumina got up to $1.5 million from the city as a tax rebate; whatever the company paid the city in new taxes, the city would return up to $1.5 million, in exchange for retaining some 330 jobs. Ballast Point got $160,000 in tax rebates to recoup what it spent on city permits and fees, and AleSmith got a similar deal for $180,000.

But when cities are giving away cash, as San Diego was in those deals, it needs to conduct a sophisticated study called a “but for analysis.” It basically attempts to say “this business would not make this investment, or add these jobs, if not for the incentive we’re providing.”

The economic development department didn’t do that.

“None of the files contained any evidence that a ‘but for’ analysis was performed,” the auditors wrote.

Caldwell said the analysis for Ballast Point, AleSmith and Illumina was informal: The companies presented evidence for what they would do with the money, or simply say what other cities had offered.

He said it doesn’t make sense to do a $30,000 analysis just to provide $10,000 worth of staff time.

“In the new policy, we should set a threshold for when the analysis should be done,” Caldwell said. “For smaller ones, it should be informal. But for those big ones where a company wants something and the City Council is interested, we agree that it’s time to do that sort of analysis.”

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