I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

I work for ThoughtWorks, the global leader in software delivery and consulting.

Monday, January 31, 2022

How City Hall Can Fight City Hall

I live in a rural area. There isn’t a whole lot of agriculture or heavy industry, but there are a lot of inland lakes and national and state forest acreage. No surprise that one of the principal industries here is tourism. It’s a year-round industry as the area supports fishing and hunting, silent and motorized water- and winter-sports, youth summer camps and RV parks. A great many of the local businesses cater to tourists, from bait shops to bars, resorts to equipment rental, boat docks and off-season boat storage.

Like any community, there is tension. One source of tension has to do with how the land is used. There are those who advocate for more motorized activities (e.g., open more roads to ATV / UTVs) and those who advocate for less (e.g., more no wake zones on lakes). To some extent, the motorized v non-motorized debate is a proxy fight for the tourism industry. It is believed that opening more roads for ATV usage will bring more people into town centers where they’ll spend money, at the cost of noise pollution. Similarly, it is believed that creating more no wake zones will reduce shoreline erosion beneficial to homeowner and habitat alike, at the cost of vacationer experience. The extent to which the tourist is accommodated is, like any economic issue, very complex: the year-round resident who is dependent directly or indirectly on tourism has different goals from those of the year-round resident who is not dependent on tourism, or the non-residents with a second home here, or the tourists who visit here for a myriad of reasons. While an economic phenomenon, it is inherently political, and there are no easy answers.

Unsurprisingly, some flashpoints have emerged. One, specifically regarding land usage, has to do with income properties. From roughly 2008 until 2019 or so, real estate in this area was inexpensive, a long-lived aftereffect of the 2008 financial crisis (fewer buyers) as well as changes in where and how people vacationed (fewer tourists). COVID-19 changed this. With international borders closed and vacation options limited, people vacationed where they had once spent their summers. Some stayed permanently. The property market went from stone cold to red hot in a matter of months as people gobbled up properties as first and second homes as a means of social distancing while working or vacationing.

COVID-19 also put a premium on rental properties. This created an acute supply shortage. Low interest rates and cash accumulated by households made for a lot of willing property investors. Quite a few bought properties, hired tradespeople to fix them up (or fixed them up themselves), and listed them on vacation rental property sites.

The trouble is, while the properties may have been improved, many didn’t get the building inspections required for an income property, nor the permits required to rent out the properties.

The zoning commission for at least one county here is treating this as a compliance problem, which of course it is. They’ve done an analysis (more about that in a bit) and concluded there are hundreds, possibly thousands of properties that are out of compliance. They have also concluded that the task of (a) ascertaining whether they are in fact out of compliance and (b) bringing them into compliance will be time consuming and difficult.

A different way of looking at this is as a fraud problem. Property owners without permits are defrauding the county (out of tax revenues) and their customers (that the property is up to building code, health & safety code, and the like).

Fraud management consists of three types of activity: prevention, detection, and investigation. Let’s start with detection. The county entered into an arrangement with a software company that analyzes rental property sites and county tax filings to identify (that is, detect) which properties are out of compliance (committing fraud). According to their analysis, there are somewhere between 700 and 2,000 potential income properties in the county without the appropriate inspections and permits.

This brings us to investigation. Two thousand properties potentially out of compliance may not sound like a lot, but it is when there are only a few building inspectors who work for the county. Plus, many of the property owners receiving citations in the mail are disputing them in court, delaying resolution and tying up an already limited staff of inspectors. This doesn’t just point out the problem of labor intensity of inspections as much as it makes clear how the scale of the problem has changed: something that had for decades been a problem at a human scale is now at machine scale. While scaling the detection of the problem was relatively easy, scaling the inspection will not. Sure, a small fleet of drones could probably assist with investigation and alleviate some of the labor intensity, but that would require the county to spend money on both labor and tech for a limited solution with no guarantee of results.

Which leads us to prevention, the third activity of fraud. The best way to make the investigation activity manageable is to prevent it from getting out of control in the first place. Yes, the numbers suggest it is already excessive, but the amount of undeveloped land in this area up for sale suggests there is room for more property development. Plus, per our earlier definition, fraud is committed with every rental of an out-of-compliance property, so in theory the intent would be to prevent the next rental of an out-of-compliance property.

Practically speaking, there is very little a single county or even a handful of counties with small tax bases can do to prevent fraud like this. Prevention will probably require state-level-legislation, and by several states. There have been similar actions taken by state governments. For example, in the past five years most states have enacted marketplace facilitator laws to make it easier for the multitude of state, county and municipal level departments-of-revenue to collect sales taxes from online marketplace retailers: instead of needing to collect from the individual merchants, the marketplace facilitator is responsible for collecting and remitting sales taxes. States could similarly enact legislation obligating property rental booking services to require listing owners to register valid permits at risk of penalty for non-compliance, and report rental data to counties where properties are rented. The onus would then arguably be on the vacation property listing sites to confirm merchant compliance, which would be checked via periodic audit similar to a sales tax audit of an online marketplace. There would still be leakage (there will always be) but not likely as much as there is today.

“You can’t fight city hall” has a different meaning today. Half a century ago, it meant the individual couldn’t expect to win a fight with a government bureaucracy. Today, a county bureaucracy can’t expect to win a fight against the modern day equivalent (socioeconomic trends of cheap capital and changing vacation patterns amplified by tech). But one thing has not changed: the underdog can only win by redefining the problem, and collaborating with many others to change the rules of the game.