Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: WEDNESDAY, August 16, 1995 TAG: 9508160047
SECTION: EDITORIAL PAGE: A7 EDITION: METRO
SOURCE: By MELVIN L. BURSTEIN and ARTHUR J. ROLNICK
DATELINE: LENGTH: Long
What is so remarkable about these two initiatives is that they are not remarkable. Competition among states for new and existing businesses has become the rule rather than the exception.
A 1993 survey conducted by the Arizona Department of Revenue found that states' use of subsidies and preferential tax treatment to retain and attract specific businesses is widespread. Half the states had recently enacted legislation consisting of incentives to entice companies to locate, stay or expand in the state. Targeted businesses have ranged from airline maintenance facilities, automobile assembly plants and professional sports teams to chopstick factories and corn processing facilities.
While states spend billions of dollars 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. Surely, something is wrong with this picture.
That is not to say that all competition among states is bad. State competition for businesses through general tax and spending policies - that is, policies that apply to all businesses - is beneficial. Such competition helps lead all states to provide the amount of public goods their citizens are willing to pay for, something that states would find difficult to accomplish without such competition. However, when the competition is through subsidies and preferential taxes to retain or attract specific businesses, it is harmful to the overall economy. Congress should use its powers to end this competition among the states.
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. They have either 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 tax breaks 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. If states are prohibited from this type of competition, there will be more public and private goods for all citizens to consume.
For example, 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 case, 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 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 were 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 ideal locations.
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 help offset the lost revenue from firms that have moved (or have threatened to move). 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.
State competition for specific businesses involves one additional loss that could make those already mentioned pale by comparison. We 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.
Some may argue there is an internal political check because if people are unhappy with their state's economic development strategy, they can move to another state or vote policy-makers out of office. However, people 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 to lead states to do what is best for the country.
The states won't end this practice on their own. There is anecdotal evidence that some state and local governments recognize they are all losing in the economic war to attract and retain businesses. Nevertheless, as long as a single state engages in this practice, others will feel compelled to compete. New York, New Jersey and Connecticut all recognized that they were losing from this competition, and in 1991 they informally agreed to stop competing with each other. It was not long, however, before New Jersey broke the deal.
How then can this economic war among the states be stopped? The framers of the Constitution, through the Commerce Clause, granted Congress the power to regulate commerce among the states for the purpose of achieving an economic union not attainable under the Articles of Confederation. To the extent this has been accomplished, the courts, not Congress, must be credited. But the judicial process is not an effective method for ending the current form of economic warfare. The variety and nature of subsidies and preferential taxes used by the states to attract and retain businesses require that Congress prohibit them. To do so under the Commerce Clause, Congress need only find that these subsidies and taxes substantially affect interstate commerce. No U.S. Supreme Court decision in at least 50 years has set aside such a congressional finding.
To illustrate how Congress might discourage states from using subsidies and preferential taxes to compete with one another for business, 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 against these financial incentives, 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.
Unfortunately, competition among states for specific businesses is commonplace and growing more costly. And it is time for Congress to act.
Melvin L. Burstein is executive vice president and general counsel of the Federal Reserve Bank of Minneapolis. Arthur J. Rolnick is senior vice president and director of research.
by CNB