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Being
from Minnesota, I can personally attest to this
rent-seeking game, as the Minnesota Twins—after a
10-year campaign—finally persuaded a previously
reluctant state Legislature to hand over about $400
million in public financing for a new stadium... Not to be
outdone, the Minnesota Vikings are currently pressing the
Legislature for their own share... And who can blame them?
As long as governments are willing to hand over limited
public resources, these teams would be foolish not to
accept them.
But
make no mistake, it's not just sports teams that demand
public money from cities and states. The state and local
funds spent competing for sports franchises, though
conspicuous, probably represent only a fraction of the
billions of dollars spent by the more than 8,000 state and
local economic development agencies competing to retain
and attract businesses through the use of preferential
taxes and subsidies. Businesses know they can get public
funding by threatening to move, forcing state and local
governments into competition for businesses that has
become economic warfare.
While
states spend billions of dollars competing with one
another to retain and attract businesses, they struggle to
provide such public goods as schools and libraries, police
and fire protection, and the roads, bridges and parks that
are critical to the success of any community.[2] Indeed,
we in Minnesota have special cause to speak to the
importance of adequate funding for infrastructure
following the tragic collapse of the I-35W bridge over the
Mississippi River. Surely, something is wrong with this
picture. As Justice Cardozo suggested, the framers of the
Constitution had something different in mind in granting
Congress the power to regulate interstate commerce under
the Commerce Clause. The objective was to create an
economic union, particularly by ending the trade war among
the states that prevailed under the Articles of
Confederation. However, it was the Supreme Court, not
Congress, that applied the Commerce Clause to end the
trade war among the states.
It
is now time for Congress to exercise its Commerce Clause
power to end another economic war among the states. It is
a war in which states are actively competing with one
another for businesses by offering subsidies and
preferential taxes. Economists find that there is a role
for competition among states when it takes the form of a
general tax-and-spend policy. Such competition leads
states to provide a more efficient allocation of public
and private goods. But when that competition takes the
form of preferential treatment for specific businesses,
not only is it not “admirable,” it interferes with
interstate commerce and undermines the national economic
union by misallocating resources and causing states to
provide too few public goods. Moreover, the success of a
state in attracting and retaining particular businesses is
not a mitigating circumstance.
This
testimony will largely concern itself with an analysis of
economic development programs and a recommendation to end
this inefficient use of scarce public resources.
...
The
economic merits of ending the war among the states
To
understand why economists conclude that the use of public
funds to attract and retain specific businesses does not
serve a legitimate local public purpose, we need to
understand what they mean by public purpose. Economists'
view of public purpose relies critically on a distinction
between public and private goods. A public good, unlike a
private good, is one in which a single person's
consumption of that good does not subtract from another
person's consumption. A lighthouse is an often cited
example of a pure public good: The light from a lighthouse
used by one ship on a foggy night does not prevent its use
by another ship. Providing for the national defense, clean
air and a legal system are other examples of goods that
any citizen can consume without subtracting from what can
be consumed by any other citizen in the community.
Besides
pure public goods there are some goods that lack the
explicit quality of a public good but give off external
effects that qualify them as such. Health care provided
to an individual is a private good because it subtracts
from the consumption of other individuals; nevertheless,
it may have external effects that are public. For example,
having one person inoculated for some communicable disease
makes for a healthier environment, and a healthier
environment is a good that any person can consume without
subtracting from the consumption of any other person.
Similarly, educational services consumed by one individual
subtract from the consumption of other individuals, but
education increases a community's stock of knowledge and
is critical to a well-functioning democracy, two highly
regarded public goods.
Economists
have found that while the production of private goods is
best left to market forces, the production of public goods
should be the principal role of government
because the market fails to produce enough public goods.
The reason the market fails is that since people cannot be
excluded from consuming public goods, charging people for
what they consume is difficult. It is often impossible to
say if and how much of a public good a person consumes.
How much does one consume of a healthy environment or
national defense or a lighthouse beam? ... Consequently,
left to the market, too few public goods, if any, will be
produced.
I
turn to the government, then, to finance and provide for
the use of public goods. Government, by its very nature,
can solve the financing problem, for it has the power to
appropriate funds from its citizens (the power to tax) for
the provision of public goods.
Solving the provision problem of public goods is more
difficult.
Competition
among states through general tax and spend policies leads
to the right amount of public goods
For
state and local governments, there is a form of
intergovernment competition that guides them to provide
the right amount of public goods. This type of competition
among government entities has been compared to the
invisible hand that guides private business to produce the
right amount of private goods.
Charles
M. Tiebout argued in 1956 that as state and local
governments compete through general tax and spending
programs to attract people and businesses, these
government entities are led to produce the desired level
of public goods. Tiebout notes that people can vote with
their feet and choose to live in the community that
provides them with the public services for which they are
willing to pay. As a result, people in effect reveal their
true preferences, and state and local governments provide
more public goods than if these governments were not
competing. The problem of providing the right level of
public goods is alleviated by competition among state and
local government entities.
But
competition among states for specific businesses is
harmful
When
states compete through subsidies and
preferential taxes for specific businesses, the overall
economy suffers. From the states' point of view, each may
appear better off competing for particular businesses, but
the overall economy ends up with less of both private and
public goods than if such competition was prohibited.
State
and local officials often boast about the new businesses
they have attracted, the old ones they have retained and
the number of jobs they have created. And in many
instances these officials should boast. Either they have
managed to maintain their tax base by enticing a local
business to stay or they have added to their tax base by
enticing an out-of-state business to relocate. As long as
the subsidies and preferential taxes given to a business
are worth less than the revenue the business will
contribute to the state over its operating years, the
citizens of the state are better off than if their state
officials had not played this competitive game. The state
has more jobs and hence more tax revenue to pay for public
goods than if it had not competed.
But
even though it is rational for individual states to
compete for specific businesses, the overall economy is
worse off for their efforts. Economists have found that if
states are prohibited from competing for specific
businesses, there will be more public and private goods
for all citizens to consume.[3] To illustrate this point,
I will consider several possible outcomes of this
competition.
In
the first outcome, no business actually moves to a new
location. In other words, suppose that each state goes on
the offensive to lure businesses away from other states,
but defensive strategies prevail; local subsidies and
preferential taxes to businesses that might consider
moving, keep them from leaving. While each state could
claim a victory of sorts (for no state loses a business),
clearly all states are worse off than if they had not
competed. Competition has simply led states to give away a
portion of their tax revenue to local businesses;
consequently, they have fewer resources to spend on public
goods, and the country as a whole has too few public
goods.
It
is unlikely, of course, that businesses will not be
enticed to relocate. In this second outcome, the damage to
the overall economy can be even greater. At first glance,
when businesses relocate there appears to be no net loss
to the overall economy; jobs that one state loses another
gains. Yet on closer examination we can see that this is
not just a zero-sum game. As in the case with no
relocations, there will be fewer public goods produced in
the overall economy because, in the aggregate, states will
have less revenue. This follows because the revenue
decline in the losing states must be greater than the
revenue increase in the winning states. (If this was not
true, businesses would not have relocated.) In addition to
this loss, the overall economy becomes less efficient
because output will be lost as businesses are enticed to
move from their optimal locations.
Each
business that is enticed to relocate represents a
potential loss of efficiency for the overall economy and
hence less output, less tax revenue and fewer public and
private goods. To be more concrete, let us suppose a
company chooses to relocate its manufacturing plant from a
warm climate state, like Louisiana, to Alaska, even though
its operating costs are substantially higher in a cold
weather climate. I will assume that the company is more
than fully compensated by Alaska for the move and for the
additional operating costs. However, it now takes more
resources for this company to produce the same quantity of
output in Alaska than it did in Louisiana.
There
is another reason businesses will be less productive when
states are allowed to compete for individual businesses.
States may increase taxes on those firms that are less
likely to move to offset the lost revenue from firms that
have moved (or have threatened to move). It is a
well-known proposition in economics that taxes generally
distort economic decisions and at an increasing rate.
Business taxes, in particular, induce firms to produce
less efficiently. ...
In
general, it can be shown that the optimal tax (the tax
that distorts the least) is one that is uniformly applied
to all businesses. Allowing states to have a
discriminatory tax policy, one that is based on location
preferences or degree of mobility, therefore, will result
in the overall economy yielding fewer private and public
goods.[4]
State
competition for specific businesses involves one
additional loss that could make those already mentioned
pale by comparison. I have assumed that states have the
information to understand the businesses they are
courting, that is, their willingness to move, how long
they will stay in existence and how much tax revenue they
will generate. In practice, states have much less than
perfect information. Assuming all states are so
handicapped, they will on average end up with fewer jobs
and tax revenues than they had anticipated, and at times
the competition may not even be worth winning.
For
example, Pennsylvania, bidding for a Volkswagen factory in
1978, gave a $71 million incentive package for a factory
that was projected to eventually employ 20,000 workers.
The factory never employed more than 6,000 and was closed
within a decade.
Minnesota's
1991 deal with Northwest Airlines is another example of a
Pyrrhic victory. A state agency agreed to provide the
company with a $270 million operating loan at a very
favorable rate of interest. In return, Northwest agreed to
build (with an additional $400 million of state and local
government funding) two airplane repair facilities that
would eventually employ up to 2,000 highly skilled workers
in an economically depressed region of the state. While
the operating loan was made in the spring of 1992, the
company has yet to fulfill its part of the bargain. ...
Despite
the fact that state deals have gone sour, some may still
be tempted to argue that competition among states for
specific businesses will lead to a good outcome for the
overall economy. Some may be tempted to make this argument
because it seems, as argued earlier in this essay, people
can vote with their feet (or vote policymakers out of
office). Hence, if people are unhappy with their state's
economic development strategy, there is an internal
political check. People, however, may not be unhappy with
these strategies—the state is acting in their best
interest. Not to compete, while other states are, may be
detrimental to a state's economy. Moreover, there may not
be a place to go because all states may be competing. For
this type of competition there is no invisible hand (or
more accurately, no invisible foot) to lead states to do
what is best for the country.
Only
Congress can end the war among the states
How
can this war among the states be brought to an end? The
states won't end this war, and the courts are not equipped
to do so. Only federal legislation can prevent states from
using subsidies and preferential taxes to attract and
retain businesses.
The
powers granted to Congress under the Constitution enable
it to fashion the legislative tools necessary to prevent
the states from using subsidies and preferential taxes to
attract and retain businesses. For example, Congress could
tax the receiving business on the direct and imputed value
of these benefits, it could deny tax-exempt status on debt
of states that offer such subsidies, or it could deny
federal funding that would otherwise be payable to such
states, much as it denies highway funds to states that
fail to meet federal pollution standards. ...
Only
Congress has the power to enact legislation to prohibit
and prevent the states from using subsidies and
preferential taxes to compete with one another for
businesses. ...
To
illustrate how Congress might discourage states from using
subsidies and preferential taxes to compete with one
another for businesses, consider the variety of subsidies
and preferential taxes a city and state might use to
attract a sports franchise away from another city. It
would not be unusual for them to offer some or all of the
following: 1) build a stadium funded by public, tax-exempt
debt, 2) lease the stadium to team owners at bargain rent,
3) rebuild streets and highways to provide stadium access,
4) loan or grant the team owners relocation funds, 5) pay
for land with tax increment financing on which team owners
can build an office building, and 6) grant the team owners
a real estate tax abatement on the building. To implement
a legislative prohibition, Congress could impose sanctions
such as taxing imputed income, denying tax-exempt status
to public debt used to compete for businesses and
impounding federal funds payable to states engaging in
such competition.
Conclusion
and a proposal for effective economic development
Unfettered
competition among private businesses has generally proven
to be a very successful economic system. ...
But
what is true of individuals acting in their own interest
is not necessarily true of state governments acting on
behalf of their local citizens. Competition among
governments based on their general tax-and-spend policies
leads to a better outcome for the overall economy.
However, when that competition takes the form of
preferential financial treatment for specific companies,
the overall economy is made worse off. Such competition
results in a misallocation of resources and, in
particular, too few public goods.
Competition
among states for specific businesses is commonplace and
growing more costly. Most states today have put in place
some type of economic development program to attract and
retain businesses. While some state officials have
questioned the economic wisdom of this type of
competition, there is little likelihood that the states
will successfully establish either formal or informal
noncompete agreements, because
it appears that the incentive to cheat is too great.
The
Supreme Court, which has, for the most part, been the
surrogate for Congress in preventing activities that
interfere with interstate commerce, is not equipped to end
this economic war among the states. To the extent that it
has power to do so, there is little, if anything, in its
decisions to date that suggest that it would.
Only
Congress, with its sweeping constitutional powers,
particularly under the Commerce Clause, has the ability to
end this economic war among the states. And it is time for
Congress to act. ...
Source
: By Mark Thoma, dated 10/10/2007
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