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Revolting Development

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At last week's mayoral debate, the only one we'll have in this year's lopsided race, Mayor Phil Gordon was asked a very good question — and gave a very disappointing answer.

Knowing what we know now, the moderator asked, did Gordon regret the city's promise to hand over $97 million in tax revenue to the developers of City North?

CityNorth, you may recall, is the development under construction at the nexus of the 51 and Loop 101. It has prime access to two highways in a schmancy part of town — and yet, earlier this year, the city agreed to bequeath up to $97 million in sales tax to the project's Chicago-based developer, just for building it.


City North

In its aftermath, the deal has become so unpopular that even the council candidates whom Gordon is endorsing, including Laura Pastor and Maria Baier, are swearing up and down that they would never have voted for it. We may be in an era of rampant corporate welfare, but this bit of entitlement was so over the top, it earned a story in the Wall Street Journal. It also inspired our state legislators to do what they should have done years ago: ban cities in Maricopa and Pinal counties from offering such massive giveaways in the future. (Supporters hope to approve a statewide ban this coming session.)

You know you've made a bum deal when our wildly divided legislature manages to unite against it. Bipartisan outrage is never a good sign.

And it gets even worse.

Last month, the Goldwater Institute, the influential libertarian think tank, sued the city. The institute argued that Phoenix's fat gift to the Thomas J. Klutznick Company is unconstitutional. The city has hired the blue-chip firm of Fennemore Craig, and its managing partner, Tim Berg, to handle its defense.

The institute's suit is a noble one. It's definitely past time that someone stood up to unchecked corporate welfare, and it's nice to see well-connected conservatives taking on big business. But the fact that we taxpayers will ultimately get stuck defending the suit is a sad irony: We're not just getting raped for $97 million. We're also stuck paying Fennemore Craig major bucks to defend the people violating us!

If there ever was a deal Gordon ought to regret, this is it.

But instead of expressing sorrow over the jam his government has got us in, the mayor did a karaoke version of Sinatra.

Regrets? He's had way too few to mention.

"I don't regret the decision," Gordon said. "I regret that we weren't able, as a community, to level the playing field so all the cities that have investments like this can share the revenue."

Obviously, it would be bad legal strategy to admit that Phoenix screwed up. But I would have loved to see at least some feigned sadness at the fallout. Maybe, "I regret that, in order to beat out Scottsdale, we had to give heaps of your tax dollars to a bunch of rich Chicago developers who don't really need it." Or, "I regret that, even though we had good intentions, we were such lousy negotiators that we gave away more than we should have, and now we're going to spend more to defend it. Sorry about that, folks."

The fact is, the CityNorth deal was ludicrous from the get-go. I've got a report from the city's own consultants that makes it clear: Even they knew we were getting hosed.

I also recently learned that, at the time the city approved the special tax gift for Klutznick, another group controlled by Klutznick and his family was actually suing the city. The Klutznicks were peeved that the city had approved a rival developer's plan for apartments near their project — even though that rival, locally owned Gray Development, wasn't getting a tax subsidy. The Klutznicks thought that Gray had been given permission to build at too high a density.

The claim was so silly that a Maricopa County Superior Court judge recently rejected it without a trial. Naturally, we taxpayers get to cover the city's defense for that one, too.

I'm beginning to see a bit of a pattern here, a pattern that seems to end, continually, with working stiffs like us and not developers like the Thomas J. Klutznick Company footing the bill.

Gordon may not regret that. But I most certainly do.

Here's another bit of irony. In next week's election, we're facing a ballot proposition to increase sales tax in Phoenix by two cents for every 10 dollars we spend. It's nothing big for small-ticket items, but collectively, it would raise nearly $60 million a year for police and fire protection.

The Goldwater Institute has been criticizing the increase by pointing out that if the city had only opted not to underwrite high-end shopping at CityNorth, we could have had that sum, in full, for nearly two years without a tax increase.

Now, the city would tell you that the institute's numbers are off. If we hadn't promised the subsidy to Klutznick, they say, the developers wouldn't have been able to build such a high-quality shopping center. You have to spend money to make money.

Plenty of people also intimate that we needed to subsidize Klutznick so that the developer could land Nordstrom, a company that might well have put another store in Scottsdale instead. Better to get half of the usual sales tax revenue from a high-end retailer than lose out on landing that retailer and end up with no sales tax at all.

Thanks to the litigation, the city's very cagey about the details of the deal. But the mayor's spokesman, Scott Phelps, told me that they're looking for CityNorth to "generate hundreds of millions of dollars for the residents of Phoenix, without fronting a single penny." The city isn't giving any money to the developers before the shops open, Phelps stresses. It's merely giving Klutznick half of the sales tax collected for 11 years, or until they reach the $97 million mark.

But there are two problems.

One is that the Desert Ridge area, where CityNorth is under construction, is lovely. Unlike Maryvale or even my half-gentrified 'hood in central Phoenix, this area could compete with Scottsdale on its own merits. In fact, Phoenix had barely begun to study the feasibility of giving the developer a massive tax break when the Klutznicks signed a letter of intent with Nordstrom. Gordon and his cohorts simply can't argue that undeveloped land near both the Loop 101 and the 51 won't attract high-end retail and plenty of sales tax, even without a subsidy.

Look at Scottsdale. CityNorth's chief retail competition is just across that city's border: a similar-size mixed-use development called One Scottsdale.

City officials in Scottsdale rejected a $50 million subsidy for that project. I'm guessing they're still going to get plenty of good shopping.

The second problem is the specifics of what Phoenix agreed to give.

The city based its offer, in part, on an analysis by a local economist. The economist, who was paid by the developer, concluded that CityNorth needed a $117 million subsidy to be feasible.

By that measure, the city's promise of $97 million doesn't look quite so bad.

But anyone who's paid any attention to development will tell you this: You can't just look at a developer's totals without breaking things down and poring over every deal. To really understand this deal, you've got to read the economist's report.

Unfortunately, that's impossible in this case. Wouldn't you know, the city didn't manage to retain a single copy of the economist's report? If it did that, of course, the report would be a public record. God knows we can't have that!

I was still able to get a summary. Under the law, the city must hire a third party to review the developer's analysis. That review, done by the national consultants Keyser Marston Associates, is a public record, and it references numerous details from the developer's report.

Most interestingly, Keyser Marston concluded that the developer's $117 million "feasibility gap" was based on a flawed number. Mainly, Klutznick had included the cost of purchasing land from an affiliate. But the $120 million land price averages more than $39 per square foot — way outside what land was selling for at the time, the consultants wrote. (Since then, of course, prices have only gone down.)

Even factoring in the developer's cost of buying out his former partners, Keyser Marston concluded, the analysis set the land price at $26 per square foot, "which seems quite high for unimproved property."

So, Klutznick was crying poor because the company was overcharging itself for the acreage. When Keyser Marston reduced the land price to something it felt was more appropriate, CityNorth's projected shortfall dropped to just $25 million.

So why is Phoenix giving Klutznick $97 million?

It gets worse.

The developer's economist built in a "required return on investment" of 9.2 percent. But the Korpacz Investor Expectation Survey, a report released by Price Waterhouse Coopers, suggests that the industry average may be a whole lot less. Like, say, just below 7 percent.

I called David Wells, a senior lecturer at Arizona State University's school of letters and sciences, to ask what that meant.

Wells did his doctorate in political economy, an experience that came in handy in analyzing the developer's projections. Change the "required return" rate to the industry average, Wells says, and the developer's projected shortfall dries right up. In fact, at that point, CityNorth could well run a surplus.

So the city based its tax giveaway on numbers that build in a large profit for the developer. And even the city's consultant, who didn't object to that part of the report, believed the developer had "significantly overstated" the cost of land.

Either something here stinks, or the canals at the Scottsdale Waterfront are acting up again.

Wells says the subsidy game has more to do with the city's desire to beat out its neighbors than any actual financial justification.

"These kind of deals only happen because we have these city boundaries," he says. "Something was going to get built at CityNorth eventually. Once people come, the retail market starts developing. It would happen naturally. You don't need subsidies for it to occur."

Unfortunately, these shenanigans happen every day. Rich developers plead poor and pit municipalities against each other for tax dollars. Cities ignore their own consultants. Our money gets channeled to private companies in the name of growing the tax base.

It's how the game has been played for far too long. Journalists rant and rave, and gadflies scream conspiracy, but nothing changes. No one has the money to fight City Hall.

No one, that is, until the Goldwater Institute decided to file suit.

Darcy Olsen, the institute's executive director, says that the genesis of the suit was a $1 million grant. With that money, she says, the institute hired attorney Clint Bolick to start a litigation center.

Preternaturally cheerful, as well as a budding novelist, Bolick is also one of the sharpest strategists in the conservative movement ("The Merry Revolutionary," March 7, 2002).

Bolick's big idea: Change the world through legal precedent. The lefties did this, of course, throughout the '50s and '60s. School desegregation, abortion rights — neither came from elected officials taking the lead. It was lawyers, and the judges who were convinced to see things their way.

As Bolick intuited, there are two sides to every coin, including judicial activism. Because of the work of lawyers like him, the courts started seeing different sorts of precedent-setting cases in the 1990s. Thanks to Bolick and the U.S. Supreme Court, poor kids in my hometown, Cleveland, can use government-financed vouchers to attend private schools. (And believe me, it would take only one hour in the Cleveland Public Schools to convince even the biggest public education supporters that vouchers are, in fact, a really good thing.) Because of Bolick's work for the Institute of Justice, Arizona residents also enjoy a much stronger right to keep their property even if the government wants to, say, turn it over to well-connected developers for some "better" use.

Bolick believes that the Arizona Constitution expressly forbids the sort of giveaway that Phoenix is attempting in the CityNorth case. Even without the botched financial analysis, he says, the government simply cannot give its bounty to private interests.

"We do not bribe businesses to come into this state," he says. "It's as simple as that."

On its face, Bolick's argument is novel. While they're not always this big, these types of subsidies have been common for years.

They have yet to face this sort of challenge, at least in Arizona.

But you only have to read the state constitution to suspect that Bolick is, in fact, right. The words seem clear. Neither the state nor any city, the constitution says, "shall ever give or loan its credit in the aid of, or make any donation or grant, by subsidy or otherwise, to any individual, association, or corporation . . ."

Hmmm. No gifts or grants or subsidies? To any corporation?

I'd like to see Fennemore Craig explain away that one. But the sad fact is, even if there is no good defense for the CityNorth deal, we're still going to be paying the firm's managing partner a whopping $450 an hour to find one.

How can we not regret that?

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