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The problem with state bidding wars and some possible remedies

Gerald W. McEntee
American Federation of State, County and Municipal Employees
Washington, D.C.

For all the attention states give to "improving the business climate," you'd think they must tax corporations pretty heavily. But they don't. Thirty years ago corporate income taxes raised more revenues than personal income taxes. But now, corporate income taxes contribute less than any other major tax. There are many reasons businesses contribute so little to support public services, but most tie back to the belief among elected officials that states must compete with one another for jobs.
Does this make sense? If, as a nation, we create no new jobs through states using tax breaks and incentives to compete with one another, then what good comes from it? The fact is that state bidding wars are damaging to all of us and simply don't work. We ought to do something to stop them and turn our attention to what does work.

The damage done by state bidding wars

Why they don't work: The jobs that incentives "create" would have been created anyway. Jobs are simply being "stolen" from other states. Governors have implicitly acknowledged this by saying states should focus on general economic climate rather than subsidies.
Moreover, tax breaks and other incentives frequently are given without adequate analysis and simply represent corporate blackmail. The progression of industries seeking tax relief in Massachusetts by threatening to leave is a recent example. First manufacturing (Raytheon) and then financial services (Fidelity) demanded preferential tax breaks. Where is the analysis on which these decisions are based? What industry will be next? Where will it end?
Finally, there is no credible evidence that incentives work. According to the Council of State Governments in Economic Development in the States (1989): "A comprehensive review of past studies on the effects of incentives reveals no statistical evidence that business incentives actually create jobs."

Who loses?

"Good" government loses: Public subsidy of business is one reason taxpayers may feel they don't get much for the taxes they pay. In addition, tax breaks for business create an environment where businesses can trade campaign contributions for tax breaks. The climate of influence peddling, corruption, bribery and blackmail fostered by such a relationship does not foster a healthy political environment.

Other state programs lose: When states give direct financial assistance, it competes with other programs in the state budget. Also, states provide huge subsidies through costly "tax expenditures." These are provisions in the tax code that reduce or eliminate certain taxes. For example, if a state exempts a business from corporate income tax, and the business otherwise would have paid $1 million in taxes, the state has made a $1 million tax expenditure. Tax expenditures frequently do not show up anywhere in the state budget and therefore are not subject to legislative or public scrutiny on a regular basis.

Individual taxpayers lose: For every dollar that business taxes are reduced, someone else's taxes go up by a dollar. Individuals end up picking up the tab for business giveaways. Since corporate income taxes are more progressive than sales and property taxes, reducing them makes a state's tax system more regressive.

Businesses lose: Tax incentives often are offered on a firm-by-firm basis. As a result, two firms selling exactly the same product with exactly the same costs for labor and raw materials may face very different tax bills. The firm without tax incentives will have to charge higher prices and will be at a competitive disadvantage.

Remedies to reduce the damage from state bidding wars

A greater federal role. At best, Congress could mandate an end to state bidding wars altogether, as economists at the Minneapolis Federal Reserve Bank have suggested. At the least, Congress could adopt a law that has been proposed by the Federation for Industrial Retention and Renewal (FIRR News, Winter 1993):

"Amend federal Department of Commerce and Department of Labor regulations to say to the States: 'If you raid jobs from another state, you lose your next year's grants.' It's just that simple."

A bill that would implement such a policy, HR 1842, has bipartisan support of the Northeast-Midwest Coalition.

Require corporate accountability. Increasingly, states realize the companies they subsidize don't always deliver what they promise. For example, Pennsylvania granted incentives of $28,000 per job to Volkswagen in 1978 to build a facility there. Eighteen years later, the factory is long gone. Now, some states are starting to ask hard questions before they give tax breaks and are putting some teeth into the aid they give.

  • Right-to-know laws provide the ability to determine whether or not the public is receiving the expected return on its investment. Connecticut's "social compact" legislation, "An Act Concerning Economic Development Program Accountability," requires businesses receiving economic development assistance from the state to list public benefits that will result from assistance, including jobs retained and created, and benefit levels. It also implements a process involving labor unions and the community to evaluate applications and monitor projects.

  • Clawbacks refer to provisions that allow a state to rescind financial assistance if an economic development project fails to achieve stated objectives concerning the number of jobs created, the length of time for which the project will operate, or other "promises" the company made when it requested state assistance.

  • Public policy tradeoffs require companies receiving public assistance to adhere to specific social or economic policies, like minimum wages, geographically targeted hiring, affirmative action and notification of plant closings. The community group ACORN actively supports local laws that restrict public assistance to companies that agree to abide by such standards. St. Paul, Minneapolis and Chicago are among the cities in which they are active.

  • A multistate industrial retention commission (MIRC) allows public pension systems to flex their considerable financial muscle. A MIRC would be created by an agreement among five or more states. The commission would investigate companies that relocate jobs and violate labor, environmental and other standards. States could adopt the following remedies: Divest the state pension of the company's stock, deny future economic development incentives and deny the right to bid on future state contracts.

Finally, state and local governments need to revisit what does work for economic development. A more efficient use of tax dollars would be to spend them on successful programs that states have found actually help create jobs. Many of these require a more patient approach to "growing" jobs, such as making investments in education and infrastructure, but pay off in a better overall business climate.

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