Clawbacks in Economic Development: Policies and Practices

by Karin Richmond, Principal, Intelligent Incentives

The term “clawbacks” conjures up a grisly picture at best. Skeleton fingers slowly creeping out of an ancient grave. “Freddy” and his vicious fingernails, drawing near a hapless victim. X-Man Wolverine slashing the latest, greatest villain.

Clawbacks in economic development are not nearly that dire, but there does seem to be some ambiguity surrounding the term. Clawbacks are more than just the payback of incentives for performance measures not achieved: They are the contractual elements that stand between the drive for economic and community development and the slippery slope of corporate welfare.

The role of clawbacks

Clawbacks have been used primarily in securing tax incentives, abatements, refunds and grants. They are distinguished from repayments or refunds as they involve a penalty in addition to a repayment.

The use of tax incentives for attracting jobs and capital investment has grown over the past twenty-odd years to include performance measures from which to gauge a company’s growth. Typical measures are 1) number of created jobs over five or 10 years; 2) annual payroll; 3) amount of capital investment over a similar time frame; and 4) amount of depreciated value in a given time. Other, more unusual measures include retaining a headquarters at a specific site for a period of time; amount of production increase or production cost decrease per unit; or the requirement to bring a given technology to market.

If a recipient fails to meet one or more performance measures defined in an executed incentive contract within a given time, a clawback may be initiated by the granting authority. The recipient is then required to return the monetary value of the incentive plus a penalty and/or interest to the grantor of the incentive, usually a local or state taxing authority. As the use of incentives mature over time, the triggering of clawbacks for non-performance will likely become ubiquitous.

Clawbacks comprising repayment and penalties insert an inherent cost of money to the private company receiving the incentives. If interest and penalties are not assessed when performance measures are not met, and the recipient is required only to repay the grant, then there is no cost to the company for the use of the incentive dollars over the years the monies were in use. The downside would not be measured in internal rates of return or interest cost, but a more subjective cost of bad company press or the likelihood of significant negative publicity in the out years should the company not meet its contractual obligations.

Clawbacks are not an all-or-nothing proposition. They may be executed in part or in full when jobs are not created, inventions not commercialized, or when property tax values dip below a stated minimum. A percentage refund, based on the number of jobs created compared to the number projected in the tax abatement agreement, is common.

Outdoor retailer Cabela’s had to repay the state of Texas $28,552 when the company fell short of hiring predictions for its Buda store. Cabela’s received $400,000 from the state’s Enterprise Fund for stores it opened last year in Buda and in Forth Worth, and the company could have earned $200,000 more if it met hiring targets.¹ Cabela’s is not protesting the clawback, according to a company spokesman.²

Texas Governor Rick Perry’s Office of Economic Development remains committed to insuring rigorous compliance by companies that have been awarded Enterprise Fund Grants or Emerging Technology Grants. “We have brought on board a full-time compliance officer and more closely tied economic development policy with activities of our office,” noted Mike Chrobak, director of the Texas Economic Development Bank. “The Governor has instituted an 11-step due diligence test every grant applicant must pass before any monies are awarded.” Clearly, the state of Texas finds that clawbacks can be useful in furthering economic development policy.

Minnesota bars companies subjected to clawbacks from receiving any incentives for five years or until the incentive is repaid. Another technique is to distribute the incentive monies after interim projections have been met and support documents have been verified.

Trends in clawbacks

At the International Economic Development Council's (IEDC) 2006 annual conference, held in September, a panel was dedicated to the discussion of clawbacks. Panelists included Samuel Lee, Senior Manager, KPMG Strategic Relocation & Expansion; John Sternlicht, General Counsel and Legislative Director for the Virginia Economic Development Partnership; and this author. The panel discussed trends in the use of clawbacks around the country, some of the performance measures they are based on, and principles for the wise use of clawbacks and incentives.

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¹Austin American Statesman, staff writer, August 15, 2006.

²Tax Incentives Alert, September 2006, Volume 5, Number 9.