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Faculty Insights

Anatomy of HQ2: A Discussion About Amazon, Subsidies, and Spin-Outs

By Clare Becker

April 23, 2019

Reporter Jonathan O'Connell gestures as he speaks on a faculty panel
Business Writer in Residence Jonathan O’Connell shares his perspective during a faculty panel at the Wisconsin School of Business. Photo by Paul L. Newby II

In February 2019, Amazon backed out of its highly visible plan to launch a second headquarters in New York City. This development provided a fitting context for a conversation facilitated by Jonathan O’Connell (BA ’01), a reporter with The Washington Post and WSB Business Writer in Residence, about the implications companies face—both positive and negative—when looking to expand or relocate, as well as for the communities where they settle. O’Connell was joined in discussion by three WSB faculty members: Dan Lynch, assistant professor of accounting and information systems; Sarada, assistant professor of management and human resources; and Russ Coff, professor of management and human resources.

Below are some highlights from the conversation:

O’Connell: What do you think Amazon did right with its search and what do you think it did poorly?

Lynch: One of the big things was that it was a really public search. I think the idea behind it was to increase competition and come up with the best economic deal for Amazon, but if they had to do it all over again, my perspective is that they wouldn’t make it as big of a public spectacle.

Coff: In the interest of being controversial, I’ll say the opposite. I think this is a case where there’s likely significant market failure. If you’re familiar with the “winner’s curse”—something I’ve studied in the context of mergers and acquisitions—it’s where you have bidders bidding for a common value asset, an asset that is worth the same to all bidders but there is uncertainty as to what that value happens to be. In this case, it’s how many jobs will be created. It’s a complex process and there’s a likelihood that the winner will have overbid.

Sarada: We can’t just say that corporations are doing something good or bad because in the end, they are getting bids from cities. These are elected officials who are making the final decision. Presumably, they’re making some calculus about what the optimization is for the people of their cities. You have a pocket of individuals—Alexandria Ocasio-Cortez comes up as a very prominent figure—who are opposed to this, but it’s unclear to me that that’s a reflection of the majority of the population.

O’Connell: Imagine there was a ban on economic development subsidies. If there were no subsidies on the table from any jurisdiction, do you think Amazon would have made a different decision in choosing Virginia and New York?

Coff: It’s rather short-sighted to try and solve this problem with tax incentives. In the long run, you need to create a human capital pool. That’s what I think Amazon cares about. There are multiple places that have the human capital Amazon wants and needs. You asked, did it change their decision? I don’t know. But it sweetened the pot for where they were perhaps going to go anyway.

O’Connell: There’s some evidence that when Amazon goes somewhere, lots of smaller companies and entrepreneurs follow. What do you make of this? Is Amazon encouraging entrepreneurship and innovation or is it stifling it—or is it sometimes doing both?

Sarada: It’s a complicated question. When you think about why Amazon chose Seattle in the first place, it’s so it could be close to the California markets and be able to price competitively (without sales tax). Amazon started as a book company, so being in a state with a high density of trees was also effective. They were able to poach from Microsoft. Amazon actually leveraged Microsoft in order to become Amazon. It had that locational benefit. This is the business of spin-outs. Companies like IBM and Intel and Fairchild Semiconductors have created a lot of spin-outs. A lot of spin-outs have come from these companies where you have a critical mass of highly skilled workers, like Epic in Madison.

O’Connell: In some cases, people have been outraged at the taxes Amazon does and does not pay. What are the areas in which you think there may be the most likelihood for action?

Lynch: Amazon is a global enterprise, so some of the changes related to the recent Tax Cuts and Jobs Act of 2017 directly affected Amazon. Its net tax rate is pretty low relative to the statutory tax rate. They use a lot of the same structures that other tech companies use, where you’ve got subsidiaries and foreign jurisdictions and the ability to run income through those foreign jurisdictions. These companies are not doing anything illegal. They’re just simply playing by the rules of the game.

Coff: I don’t think it’s reasonable to blame somebody for obeying the rules and paying the minimum tax that actually is required. It has to do with how the rules are set. Why blame the taxpayer?

O’Connell: Do you think that New York collectively made a mistake that resulted in turning Amazon away?

Sarada: Absolutely, based on the lack of information. For example, when Foxconn announced it was coming into Wisconsin, we could do calculations of what the per-taxpayer cost is for the subsidy it received. In the Amazon case, I’ve never seen a clear calculation of what the per-taxpayer cost is. If you know what the cost is going to be, then you can set that off against some projections of externalities and growth.

Coff: My suspicion is that probably New York overbid, offered too much in subsidies. I suspect that the human capital is there. People do want to live in that area. What’s the extent of the benefits that the city and community would get? We will never know.

Lynch: Amazon is unlike any company that we’ve examined in the past. Some of the empirical research on things like enterprise zones, for example, where a state sets up a zone trying to incentivize firms to locate there with jobs, show mixed results. Studies that look at a specific enterprise zone sometimes find some positive effects.

We don’t really know if Amazon is receiving tax incentives. Under the current accounting rules, firms are not required to disclose in any way these types of tax abatements or tax incentives. The Financial Accounting Standards Board is currently debating whether or not firms should actually disclose these incentives. The only disclosure requirement is at the government entity level, so New York, for instance, has to disclose the amount of tax incentives it is giving out, but it doesn’t have to disclose who they are to. It’s a significant area of research in accounting right now: Should firms be required to disclose this information?