Subsidies and Fee Reductions: The Myth of the $67 million Giveaway

“A lie makes its way halfway around the world before the truth can get its pants on.” — Attributed to Mark Twain — falsely

Few words grate on taxpayer sensibilities like “subsidy.” In recent months — likely because we’re in an election season — we’ve seen many allegations on social media and at council meetings that the City has given subsidies to everyone from Google, to other tech companies, to housing developers. Perhaps most notoriously, politically-motivated interest groups, pundits, and (sadly) politicians have asserted — and the media has uncritically parroted — that Council and I somehow granted high-rise developers a $67 million “giveaway” — despite the fact that the public coffers never lost a single dollar.

We can all agree that taxpayer dollars bequeathed by City Hall to “fat cats” in industry or development — whether in the form of direct payments or fee reductions — would be far better directed toward our city’s many needs, starting with many basic services like police patrols, trash cleanup, and homeless housing. Accordingly, the criticism of any big “giveaways” would be fair, if it were true.

But it’s not true.

In my tenure as Mayor, I’ve declined to sustain subsidy programs. As a councilmember a decade ago, I publicly criticized San Jose Redevelopment Agency subsidies for everything from poorly performing tech incubators to retailers to business clusters. [1] I asserted that subsidies were poor uses of scarce taxpayer dollars, and that government agencies were not particularly adept at picking winners and losers. I also argued that subsidies distort efficient market outcomes, putting a thumb on the scale of competition, and increasing risk of public corruption. In a book that I distributed during my mayoral campaign, I publicly vowed to stop using subsidies as an economic development strategy.

And I’ve kept my commitment. In my five years as Mayor, virtually every subsidy program in the City has expired or halted — with three (arguable and) readily distinguishable exceptions. First, during the pandemic, we’ve used Federal “Cares Act” funding to assist daycare providers, restaurants, and other struggling small businesses with small emergency grants. Second, to stimulate construction of more affordable housing in 2019, we reduced permit fees to individual homeowners seeking to construct “backyard homes.” Third, longstanding programs to reduce landing fees and other airport charges have continued as a strategy to attract new flights — particularly international flights. Each of those instances present special cases, the first two for obvious reasons, the third for reasons I’ll discuss below. None of them are consistent with the pundit-spun narrative that the City subsidizes big developers or Big Tech. And other than those three small very limited exceptions, City subsidy programs have gone away. Despite the elimination of those subsidies in my tenure, San Jose made unprecedented gains in economic development in recent years prior to the pandemic, securing more new headquarters and tech office expansions than any time in its history.

[1] Before my tenure as Mayor, in 2010, I did push to reduce parking fees for small retailers, restaurants, and other businesses to encourage tenants to locate in Downtown during the depths of the Great Recession amid soaring vacancy rates. It remains arguable whether the City would have received any more parking money without the incentive, in light of the widespread vacancy.

What is a Subsidy — and What’s Not

It’s important to have clarity about what subsidies are to clearly understand what they’re not. Simply cutting fees, reducing taxes, or cutting red tape across-the-board is not a subsidy — particularly in those instances where high city fees impose insuperable barriers to economic activity. Sometimes we simply reduce fees across-the-board because we’ve learned that they’re prohibitively high for everyone, and those fees squelch the very activity that would otherwise more generate fees to the City. Our “backyard home”/ ADU program provides a good example; homeowners appeared reluctant to bother with a City process that appeared too cumbersome and too expensive — so we streamlined the permit application and cut the fees. To distinguish the “subsidy” from any garden-variety fee reduction, the public should critically ask two important questions:

· Is the public losing any revenue as a result of the fee or tax reduction?

· Are the fee reductions available only a select few competitors in the market (as opposed to being offered universally)?

These two questions provide insight about who’s giving and getting what — and why. If the answer to both questions is “no,” then virtually no economist would consider the action of the government agency to be a “subsidy.” The uniform reduction of an onerous fee for every permit applicant isn’t a subsidy — under any standard definition that can be found in the City’s ordinance, or in any dictionary.

Tech Companies Don’t Get Subsidies

What tech companies in San Jose have received a “subsidy” in my five years as mayor? None. Indeed, when Amazon launched its nationwide “HQ2” contest to encourage cities to outbid each other with tax breaks and public handouts, I wrote an op-ed in the Wall Street Journal with a simple, emphatic “no thanks.” In contrast, other cities and states throughout the country attempted to woo Amazon through multi-billion-dollar packages of tax rebates and exemptions. Tech job growth certainly hasn’t flagged in San Jose as a result.

Google, long a target of criticism by a few politically-motivated groups, provides a telling counternarrative. The company embarked on its Downtown campus only after I insisted — and senior executives emphatically agreed — that there would be no subsidies, no tax breaks, no special deals on land, and no fee reductions. Indeed, consider what Google has already publicly committed to providing our city, in part through a signed memorandum of understanding, based on current projected build-outs reflected in the latest public plans:

· paying millions of dollars in community benefits,

· absorbing tens of millions of dollars of commercial linkage fees for affordable housing

· purchasing City land at prices far higher than the City’s own appraisal, again at a cost of tens of millions of dollars,

· building energy, water, and sewer infrastructure in a utility-deprived part of Downtown at a cost of hundreds of millions of dollars to achieve ambitious zero-net-energy goals,

· agreeing to construct about a thousand units of affordable, rent-restricted apartments within the urban village.

All of this constitutes a dramatic and commendable departure from the subsidy-grabbing approach of companies in other cities — and will become a national model for corporate responsibility.

What about all of the other tech expansions in San Jose? Global brands, including Adobe, Amazon, Broadcom, Google, Hewlett-Packard Enterprises, Micron, Microsoft, Roku, Western Digital, Verizon, and Zoom have either substantially expanded or moved their headquarters into San Jose under my tenure. None received a dime in city subsidy. In my very first months in office, a builder for Splunk’s first San Jose office completed its construction on a project that had already secured commitments to utilize a pre-existing, Great Recession-era program that reduced construction fees to all large employers moving into San Jose. No other companies got even that much.

Some might point to EBay’s gains in last year’s tax revenue-sharing agreement with the City amounted to a corporate giveaway of some sort. Yet scrutiny of the deal’s terms reveals that City taxpayers can only gain from the deal: the City garners more than $20 million in revenue it would have never otherwise received without the agreement.

High-Rise Housing — the $67 Million Giveaway?

What about the hubbub over reducing fees on high-rise housing? What about the alleged $67 million giveaway to high-rise builders?

First, some context: very high-density housing — of a dozen or more stories — is precisely what urban planners have long urged us to build in Downtown, for a host of reasons. High-rise living is much more environmentally friendly than suburban single-family housing — downtown residents use half as much water, require far less heating, and take far fewer car trips than denizens of single-family housing. It produces much less traffic on our freeways than traditional, sprawling suburban housing, and can reduce the burden of auto ownership on tight budgets. It supports the growing vibrancy of downtown by adding the “feet on the street” that represent residential customers for retail, restaurants, and amenities. Unlike single-family housing, it actually provides more revenue to City coffers than it extracts in city services. Perhaps best of all, high-rises enable us to add hundreds of units to our very scarce housing stock relatively quickly, and without all of time-consuming political and legal battles from sensitive suburban neighbors.

So, we should all want more high-rises Downtown — to provide more housing, to improve the environment, to make our Downtown more vibrant, and to bolster the City budget. The problem has been that we generally can’t get much high-rise housing built. Nobody has broken ground on a high-rise residential tower in three years — despite the pre-pandemic building boom in nearly every other major US city. The unique challenges to building residential towers in San Jose — extremely high labor costs, chronically high land costs, a high-water table, and an airport flight path that prevents construction of virtually anything more than 30 floors — have suppressed construction of that housing in Downtown. Builders can’t get financing from lenders discouraged by the high development cost here. If the costs are too high, and the profit margins too low, neither investors nor banks will choose to take the risk. So projects sit on the books, and never get built.

The proof? Compare our diminutive skyline to that of any of a dozen cities that are smaller in population than San Jose: Seattle, Denver, San Francisco, Miami, Boston, or Austin, for example. Our City doesn’t bat its weight in high-rising housing. So, our Downtown languishes.

So, 15 years and three mayors ago — before I joined the City Council — the City first proposed reducing park fees on high-rise towers help builders get financing they need to get a shovel in the ground. (That Council also injected millions of public Redevelopment Agency dollars into high-rise projects, a practice that the City has — with better sense — abandoned in the last decade.) Ironically, it was proposed by a union-backed Downtown councilmember, Cindy Chavez — in contrast to the outspoken opposition by several unions to the idea today, and supported across the political spectrum. The initiative helped — four towers broke ground by 2008.

The result of those four projects was instructive, however: two of those four developments went into bankruptcy within a year of their completion. Simply, the margins were very low, and the financial risk very high.

When the fee reductions expired, builders stopped building — for several years. We broke the streak with the completion of One South Market in 2014 — but only after cutting fees back to their earlier levels. Since then, only four more high-rise housing projects have broken ground — amid a construction boom virtually everywhere else. By comparison, the Seattle skyline featured an explosion of 63 high-rise cranes at one point in 2017. Even our very modest progress was undermined by the looming expiration of the fee reductions by 2017, as prospective lenders and investors backed off any new projects. Meanwhile, construction costs continued rising rapidly, according to a well-publicized report by Turner & Townsend, making Silicon Valley the most expensive place to build an apartment building in the nation, and by some measures, in the world. Rent growth also flattened, averaging 1.9%, 3.3%, and 2.1% in San Jose in each of the years between 2016 and 2018 (Strategic Economics, 2019). Two independent consultants studied the issue, and both deemed that high development costs made residential towers in San Jose infeasible — that is, they prevent high-rise builders from getting the financing they need to break ground.

So, in September of 2019, we held a public hearing, considered the evidence, and extended the fee reductions, against the vociferous protests of several unions and their political affiliate, Working Partnerships. They argued that the fee reductions somehow provided $67 million of “subsidies” to developers, a provocative accusation that was rebroadcast by several media sources that never bothered to scrutinize the veracity of the claim. Of course, the allegation was false: City would never collect a single dime of those “foregone” fees, because builders don’t pay fees on projects they can’t build.

So, why did some unions protest when the City agreed to reduce the fees? Politics — and the ongoing battles between union and non-union contractors. Unions have long wanted the City to impose requirements on private construction that would favor contractors using union labor. An agreement was struck in 2018 between the City and unions — primarily to avoid a union-backed gross receipts tax measure that many employers viewed as a job-killer — and under that agreement, the City cannot offer subsidies to any builders without imposing costly mandates that heavily incentivize the use of union labor. A subsidy would trigger a requirement that contractors sign project labor agreements (PLA’s) on private construction projects, which many contractors find onerous because of mandated contributions to union-sponsored retirement plans — even where they’re employers non-union workers who will never benefit from those plans. Imposing PLA’s would essentially clear the field of non-union contractors on many projects in San Jose, and drive the already-high cost of construction even higher. Studies have found that PLA’s typically add between 15–20% to the construction project’s cost — in the very region that already bears the nation’s highest construction costs. So, the City has sought to avoid triggering that clause, steering clear of subsidies. Unions have argued that any fee reduction is somehow a subsidy — despite the contrary language of the 2018 Agreement. So, the word “subsidy” has become a political football.

Those same union-aligned critics assert that the fee reductions have only favored “luxury housing,” at the expense of affordable housing. The facts say otherwise. The Graduate, one of the last two high-rise towers to break ground Downtown, features four beds to a single apartment (specifically, housing 1,039 rent-paying residents in only 260 units). It’s marketed heavily to students, is only a short walk to the SJSU campus, and hardly constitutes luxury living. Similarly, StarCity seeks to build an 800-unit high-rise concept that will be affordable-by-design for a modest-income workforce by relying upon a similar shared-space, small-unit, co-living concept. Nonetheless, StarCity remains unable to get financing today.

Airport Fees: The Final Subsidy

There is one very limited area where, arguably, the city does still offer subsidies: for new airline routes. The City has done so for more than a decade. Context is important, however. Every major city in the United States reduces airport fees — and in some cases, offers outright cash subsidies — to lure airlines to launch new routes at their airport. The City of San Jose’s fee reductions appear more modest than most, but extensive market analysis has revealed that the City could not be competitive in securing any new routes — which provide large multiples of economic benefits to city hotels, restaurants, taxi and ride sharing services, and others — without some fee reduction for new flights. The deals typically call for airlines to pay fees that the airport “shares” with the airline to pay for marketing of the new route, with City input about how the money gets spent.

Three facts clearly distinguish these airline subsidies from City subsidy programs of the past — particularly during the pre-2011 Redevelopment era. First, airport-related incentives do not divert a single dollar from City responsibilities for police, parks, parking enforcement, or any other program. How can I be so sure? Because federal law mandates that every dollar of airport fee revenue must be spent within the airport, for aviation-related purposes. So, fee or no fee, non-airport services cannot be affected. Second, the fee reductions have worked. San Jose-Mineta has landed more than three dozen new routes in the four years prior to the pandemic, and for two consecutive years, our airport has grown faster than any other in the United States. Third, no discernable adverse fiscal impact resulted, as revenues at the airport have surged since 2015, and the airport appeared financially stronger pre-pandemic than any time in nearly two decades.

Holding Government Accountable — With Examined Facts, not Echoed Fallacy

In any election season, savvy interest groups with clear power but murky intentions will seek to spin the public with misleading messages that — if repeated enough — will to take on an air of unquestioned authority. So it is with the mythical $67 million developer subsidy, which seems to appear repeatedly in the media without scrutiny. Yet the public deserves to hear the facts — from the media, from their elected leaders, and from independent sources. The prior discussion makes two facts clear: first, while I’ve been Mayor, we haven’t offered any tech companies a dollar of subsidy. Second, no taxpayer money has been expended or lost to support a high-rise developer under my tenure; without the fee reduction, builders could not get the financing required to build projects that would pay any City fees anyway. With the fee reductions, San Jose has benefitted from the construction of thousands of units of Downtown housing, in the most environmentally and fiscally sustainable way to build housing — and at a density intrinsically more affordable than single-family housing.

There are plenty of reasons for the public and media to closely scrutinize public-private relationships, and to call foul where any whiff of an overly cozy relationship becomes apparent. But let’s do so in a principled way, focus on facts, and apply our judgment consistently. While government deserves much of the skepticism to which it is subjected, sensible reform starts by focusing our energy where there’s fire, and not merely smoke. It’s time to clear the smoke, and expose the facts.