August 30, 1996 - From the August, 1996 issue

Cities Now Compete For Retail & Sales Tax—But At What Cost?

By Allan Kotin. He is a Principal of Sedway Kotin Mouchly Group (SKMG), a broad-based real estate consulting firm servicing clients in both the public and private sector. Mr. Kotin has more than 30 years of experience in the real estate business and extensive experience with real estate consulting firms and developers. He is also an Adjunct Professor at the University of Southern California’s School of Urban Planning and Development, where he teaches “Public/Private Joint Ventures,” “The Development Approval Process” and “Real Estate Finance.” He is a vice president of the National Council for Urban Economic Development (CUED). His educational background includes Harvard University and UCLA, and he holds Bachelor’s and Master’s Degrees in Economics.


Allan Kotin: “The introduction of a large, new big-box retailer into an area would almost seem to guarantee a net increase in retail sales taxes to the jurisdiction… How much of this increase is actually being diverted from other retailers in the same jurisdiction?”

The limitation on property taxes imposed by Proposition 13, combined with an almost complete withdrawal of federal and state support for municipal governments, has created a renewed focus on the need for additional retail sales taxes as the only manageable source of general funds for California cities. 

One manifestation of this trend has been a growing pattern of public assistance and encouragement of large retailers to locate within cities, particularly small to medium-sized cities. At the same time, there has been an increasing groundswell of resistance to this pattern of public assistance for retail. 

The Issue 

The issue is not whether large retailers can move into any market. They are guaranteed that right by our Constitution and legal structure. The issue is whether they should be given assistance by the host city government. 

Assistance takes several forms, the most common of which is some type of financial assistance in reducing the cost of land or infrastructure. Less common, but also present in many situations are favorable treatment with respect to impact fees, processing fees, or favorable zoning. The objections to this type of assistance stem from three main sources, which are the subject of this article.

The first, and perhaps the least important is the challenges to the use of public lands for private benefit. That challenge has been around for a long time, and it does not represent any new trend. 

Two more important sources of objection which have surfaced in the last several years relate to whether the benefits claimed for the retail use are real and properly measured, and whether the presence of the new retailers will harm existing local merchants. 

Recent Case Studies 

Three recent situations include: 

  1. Shopping at the Rose, a power center located in Oxnard;
  2. a proposed power center at the intersection of Wendy Drive and the 101 Freeway in Thousand Oaks, generally referred to as the Seventh Day Adventist Property
  3. and a recently-rejected Home Depot store proposed for the city of Riverside. 

In all three instances, concern was raised about the adverse impact these new centers would have on the local merchants. In each case, the extent to which benefits would be incremental to the community was questioned. 

The Shopping at the Rose project was structured to make the public assistance contingent on benefits, with measurement of the benefits designed to eliminate some of the transfer effects which were sure to occur, at least from the larger merchants. 

The Seventh Day Adventist Center in Thousand Oaks was approved with significant reservations by the Planning Commission. Since no assistance was involved, the primary issue was how best to protect local merchants. 

In Riverside, a relatively modest assistance package for Home Depot to be located in a deteriorating redevelopment area, was rejected on the grounds that the benefits proposed were not really net benefits to the community. 

The Logic of These Arguments 

It is important to emphasize that in each of these instances, and in most such situations, the critical issues are not creating or saving new regional shopping centers. Nor is the central issue one of rehabilitation.

In both cases, the arguments are much more complicated and the basis for public assistance is much broader than just revenues generated. Often, redevelopments of this type are perceived as beneficial rather than harmful to local merchants. 

The first big argument is always about whether there is any real net benefit. At one level, it seems like a silly question. The introduction of a large, new big-box retailer into an area would almost seem to guarantee a net increase in retail sales taxes to the jurisdiction. This, however, leaves two critical questions unanswered.

The first is how much of this increase is actually being diverted from other retailers in the same jurisdiction. The second, which is only occasionally asked, is how much of this increase would have occurred without any public assistance. 

The real benefit of new retail projects from a fiscal impact or public revenue point of view is theoretically the product of a four-step calculation:

  1. First, establish the gross taxable sales;
  2. Subtract from that amount the sales that are transferred from other outlets in the same city;
  3. Subtract from that amount the additional public service costs associated with the new outlet;
  4. Subtract the revenues that could reasonably have been anticipated from development of the site without pub­lic assistance.

Very few jurisdictions understand this process well. Many take the first two steps, but not the third and fourth. Usually, the adjustment for public service costs is not particularly large. The adjustment for revenues that would have occurred without public assistance is problematic, because it requires making assumptions about whether development of the proposed retail outlet would occur without public assistance. 

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The recent experiences of both Oxnard and Riverside illustrate two aspects of this benefit computation. 

In The Shopping at the Rose project in Oxnard, there was an explicit acknowledgment that the new Sam's Club warehouse and several of the other stores would have an adverse impact on the existing Price Club and probably on Kmart.

While there was no good way to measure the full transfer impact, these two aspects of the transfer were identified and incorporated in the formula which governed the eligibility of the developer for the public assistance. Specifically, sales losses at Kmart and Price Club were deducted from the sales of Sam's Club and other merchants in the new center in order to determine whether there were true net sales tax benefits on the basis of which certain obligations of the developer to the city were forgiven. 

The Home Depot case in Riverside posed a different, but related problem. There were many Home Depots already serving Riverside from just outside the city's boundaries, as well as a variety of independent hardware retailers. The hardware retailers argued successfully to the city council that many of the new sales would occur at their expense, and public subsidy in any form to Home Depot was inappropriate. 

They made the point that they had already sustained the damage associated with competing with big-box retailers, many of which were on the fringe of the city and overlapping trade areas. This defeats the argument that is often used to counter local merchant protests by saying that big-box retailers will move in anyway, and the only issue is whether they move into the city or just across the city limit.

The smaller hardware stores are vulnerable to challenge by the Home Depots and Home Bases of this world, whether or not they are in the same city. In the case of Riverside, this impact had already been absorbed by the retailers, and they felt that further subsidy of another Home Base within their community, directly competing with them, was not justified. 

Protection of Small Merchants and Downtowns 

This leads indirectly to the most problematic and difficult of the bases for opposition to new retailers—the protection of local small merchants and local downtown or traditional shopping areas. 

There is a widespread belief that new large shopping centers that offer a wide variety of goods will attract precisely those merchants who now occupy key locations in the downtown or traditional strip shopping areas of smaller cities. Even if they do not attract the same merchants, they will offer much more potent competition, and the existing downtown areas will suffer further. 

This is a legitimate concern, since these areas offer benefits and functions to the community beyond simple generation of retail sales taxes. Accordingly, a frequent concern of planning commissions and city councils is how to avoid hurting their local merchants and downtown areas. 

The problem here is a pair of easily confused statements that are not at all the same. One is: If this new shopping center comes to town, it will hurt the downtown and local merchants.

The second is. If we keep this shopping center out, the downtown and local merchants will be protected and will continue to thrive.

The negative impacts of modern larger-scale shopping on local merchants cannot be avoided by simply keeping a particular large-scale project out of the city. Power retailing is here to stay. 

The impact of big-box, value-oriented retail will inevitably occur and affect every retail sector. This can only be slightly blunted if such stores are kept out of town. Legally, they cannot be "kept" out of town; the only real issue is to deprive them of public assistance. In today's environment, however, such stores are not as likely to go where there is no assistance.

Survival of Small Retailers 

The key issue for small-town retailers is not how to keep out the competition, but how to differentiate themselves. The survival of the Thousand Oaks Boulevard corridor, downtown Monterey Park, and a variety of other locations threatened by larger-scale retailing is not a function of how well they can keep out promotional retailing, but a function of the extent to which they acknowledge its presence and differentiate themselves. 

What are the mechanisms of differentiation? The primary mechanisms are service, variety and experience. Power retailing is predicated on offering goods at a very low price with a minimal shopping experience. Often, they offer only very limited service. 

Smaller retailers can compete by offering a broader range of merchandise, a higher level of service, or a better shopping experience. Even so, small retailers are likely to lose out because of their inability to market competitively in the media. The key to restoring and maintaining downtown is collective and aggressive marketing. This is not an easy prescription to follow, nor an assurance that it will succeed. 

The key issue is to focus on how to differentiate downtown and local merchants rather than attempting to halt or deflect a wave of new stores and centers which will not be stopped. At the same time, constant vigilance with respect to the proper measurement of real benefits is critical in an environment where assistance is becoming the norm rather than the exception in attracting major new retailers. 

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