DC’s LivingSocial Cronyism Experiment Already Going off the Rails

by on November 29, 2012 · 5 comments

In July 2012, the D.C. Council approved the Social E-Commerce Job Creation Tax Incentive Act of 2012. The deal provided LivingSocial, a popular online coupon service, with corporate and property tax exemptions in Washington, D.C. worth approximately $32.5 million over five years beginning in 2015. Legislators feared that LivingSocial would relocate to areas with a lower tax rate. In exchange for the $32.5 million, LivingSocial said it would attempt to add 1,000 employees to its payroll (roughly doubling its number of employees in the District), although no contractual guarantee for job creation exists and even though the firm had never been profitable. Some of the few contractual obligations required for LivingSocial to receive these tax exemptions are that it must establish a program to mentor D.C. high school students, provide internships for D.C. students, and stay located in the District. LivingSocial must also ensure 50% of newly hired employees live in the District in order to receive the Act’s full $32.5 million in exemptions.

Just a few months after the deal was struck it had already become apparent just how risky of a bet the DC government has made with taxpayer dollars. In late November 2012, LivingSocial announced a net loss of $566 million for the third quarter and that hundreds of employees would be laid off. The promise to roughly doubling the size of its DC-based workforce seems fairly unlikely and some analysts doubt the company will survive much longer.

This serves as another case study for just how foolish it is for governments to make risky, taxpayer-backed bets on information tech companies. Sadly, it’s not the only case study in this regard. In a forthcoming white paper, Brent Skorup and I will be documenting the troubling rise of high-tech cronyism across America. Motorola, Apple, Facebook, Twitter, Groupon, film studios, video game makers, and many other information technology companies are lining up with hat in hand and asking for handouts or special favors from state and local governments. Tax credits and other tax code-based inducements (such as tax rebates) are being tapped increasingly by state and local lawmakers who hope to encourage investment by these companies.

This cronyist activity is troubling for many reasons. As Brent and I will argue, tax credits and other benefits for digital technology companies are particularly misguided since (a) the most successful companies certainly don’t need them; and (b) the smaller companies or startups that might benefit from them today probably present a very risky investment for taxpayers. Many of these companies may be here today but gone tomorrow. That appears it could be the case for LivingSocial.

Tax credits can also become a time-consuming morass for innovators and distract them from the entrepreneurial activities they should be focused on. A recent Wall Street Journal report noted that “many companies are saying ‘no, thanks’ and are likely paying more taxes than legally required,” because “the tax deductions are either too cumbersome or too confusing. In some cases, the cost of obtaining the tax benefit is greater than the benefit itself.”

Policymakers should leave such risky investments to venture capitalists and others so that taxpayers are not on the hook when things go off the rails, just as they already have in DC with LivingSocial. Generally speaking, the best industrial recruitment / retention efforts are simple rules, low taxes, and light-touch regulation. That’s how to attract and retain a base of serious high-tech innovators without putting taxpayers at risk when things go wrong as they so often will in this sector.

Update: Shortly after I posted this piece I was contacted by representatives of the D.C. Mayor’s office asking me to clarify for readers that LivingSocial cannot claim any of these tax benefits unless it has 1,000 employees in city and unless it creates a 200,000 sq. ft. headquarters inside the District. They also asked me to again stress (as I noted in the opening paragraph) that these benefits will not begin until 2015-16. The exact terms of the deal can be found in the first link provided above (click the bill name).

In theory, such strings and stipulations could help the DC government escape this mess before it becomes an embarrassing fiasco for the city, but I would argue that they should not be putting taxpayers at risk like this to begin with. Moreover, while more strings might seem to provide greater accountability, added requirements and red tape also create more hassle and costs for firms. As I noted in my essay, that can affect future innovation and entrepreneurialism. Special deals for risky tech ventures remains unwise public policy.

  • http://icecreamheadache.wordpress.com Libby_J

    Good to know the mayor’s office is monitoring your blog.

  • Honestly Confused

    These are only tax exemptions, right? As in, I’ll charge you less taxes if you fulfill this contract. In that case, nothing happens if the company posts loses and/or goes broke in the short term since then there wont be any taxable income under that company’s name, so where is the “risk” for the state and local goverments in these arrangements?

  • http://twitter.com/GannforDC Gann for DC

    $32.5M could support a lot of improved infrastructure that would entice MANY firms to stay and grow in the city — not just one risky one.

  • TheBrett

    Yeah. That was a fast reaction – either someone has pushed your post through other channels, or they’re following the blog.

  • Christian Rice

    The risk is that the government is spending $32.5 million on anywhere between 0 and 1000 jobs. In fact, even if no one is hired in D.C., LivingSocial (LS) still gets $16.5 million according to D.C.’s CFO.
    But let’s say that D.C. was smart enough to ensure that LS must create jobs in D.C. to receive the tax break, it’s still a huge risk to the taxpayer:
    What if I were to tell you that I have a crystal ball that can see into the future and I’ve looked into this ball and seen a future where no the government didn’t give LS a tax break coupon. In this future, LS moved away from D.C. and 500 D.C. residents lost their jobs. Six months later, ten new small businesses moved into LS’s old headquarters because the rent price had gone down as the owner of the property needed someone to pay rent. If the rent hadn’t gone down, these new small businesses never would have been able to afford their new businesses. One new business hired 20 employees right away and, after several months of profit, they hired 100 employees. After 3 years, they have grown to 15,000 D.C. employees and are paying a higher tax rate than LS. This is just one of the MILLIONS of scenarios that the government could be preventing by incentivizing LS to stay here. So the government is taking a risk by assuming that LivingSocial’s staying in D.C. is the optimal outcome for D.C. citizens. Does the government know that this is the best option for D.C.? Of course not, it cannot predict the future – it is just guessing.
    So it’s a risk because the government is using taxpayer money to gamble with our future. With these tax breaks, we could be preventing innovation and incentivizing failing companies when successful companies could make profit in D.C. instead.
    And besides, is it really fair for the government to give a single D.C. company an advantage over every other company in D.C.? If I were a LivingSocial competitor (or planning on starting a new company similar to LivingSocial), I would be livid that they are being favored over my company because tax breaks allow companies to lower prices (since they don’t need as much revenue to meet expenses), and these lower prices could run me out of business. Tax breaks meant for one single entity is not good economics.

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