1996-1997 Essay Contest

First Place Essay

The Economic War Among the States
Subsidizes Inefficiency

Benjamin Joshua Katz
Memorial High School
Eau Claire, Wisconsin


There is an economic war occurring among the states that has become intense. Competition to attract businesses has sent state and local governments pandering in ways that are not healthy for the economy as a whole. In the past, competition among states prompted the creation of a pro-business climate that allowed companies to flourish in a free market. Today, economic development specialists offer new, expanding and relocating targeted businesses direct incentives such as low-interest loans, tax abatement and outright grants. With each new innovation by one state's economic development council, other states struggle to match and sweeten deals.

The end result of this competition for businesses among the states is a zero-sum game, at best. The offering of incentives allows—indeed, promotes—inefficiencies that reduce free market productivity. Incentives add up to taxpayers funding business, and government overstepping the bounds of its logical, if not constitutional, place in commerce. Therefore, it is in the best interest of all that we pass federal legislation that ends the tactics currently used to draw businesses across state lines.

Incentives began as an attempt to regain business lost to foreign competition. One of the first major cases that showcased the efficacy of incentives in attracting foreign businesses was Pennsylvania's 1976 landing of Volkswagen by offering $86 million in incentives. The Pennsylvania economy was hard hit by the loss of many steel industry jobs to foreign countries. Likewise, Mercedes was offered almost $200,000 per job created at a plant in Georgia. Since that time, states have jumped on the incentives bandwagon seeking to keep a competitive business climate consistent with that of other states. Incentives have been used with increasing frequency to attract U.S. companies to a state. An example is Amarillo, Texas, which sent an $8 million check to each Fortune 1000 company that could be cashed, essentially, as soon as the company created 700 new jobs in their community. While incentives may help a local economy in the short term, the practice of offering incentives is a net loss for all.

There are three major problems that result when states interfere with commerce in this fashion. The first problem is that which the Minnesota Twins are likely to illustrate in the near future, and as the Milwaukee Brewers have this past year. The outcome is that businesses stay in their original locations. What occurs is this: States try to lure businesses away—or businesses go out "incentive hunting." Here, the current location is successful in keeping the company (or ball team) in their hometown. But to achieve this, the local government has been forced to match or better incentive packages that the business has scouted out. In such situations, competition among the states leads to tax revenue being appropriated to a business to keep them at the site that they are already in. The state now has less money to supply public goods, which can benefit all. This amounts to corporate welfare paid for by taxing the masses.

A second problem with offering incentives occurs when the businesses are indeed lured by outside communities. While this may help the region that welcomes new business, as a whole we are no better off—nothing but a transfer of jobs between sites has occurred. Again, the outcome is disadvantageous to the citizens of both states. The original state's economy suffers due to a loss of trade, and the new location suffers (though it may be offset by local gains) because the government cannot provide the same level of public goods, as their tax revenue has been diverted to the private sector.

Offering incentives to businesses creates a third problem that leads to inefficiency. For example, a corn mill may locate in, say, Georgia, 800 miles from corn, because Georgia's government is offering enough in terms of incentives so that the company can still meet its bottom line despite the high costs of transportation. In this case, the greatest advantage of the free market, productive efficiency, is lost, or largely distorted, by the incentive. Thus, while the corn mill could be located, logically, in Iowa, the taxpayer absorbs the cost of transportation of the corn. This is a negative-sum game for the consumer who, although buying cornmeal for the same price in the supermarket, is actually paying more because his taxes have gone to fund the inefficiency of the business, by way of incentives. In addition, the inefficient location of the mill leads to unnecessary depletion of natural resources due to the extra transportation required.

Also to be recognized is that the granting of incentives disfavors businesses unlikely to relocate. These businesses will need to pick up the tax burden left due to the incentive programs' offering of tax abatements. According to Melvin Burstein and Arthur Rolnick, both of the Federal Reserve Bank of Minneapolis, "Taxes generally distort economic decisions," and thereby limit the power of the market to yield the stupendous productive efficiency it is capable of promoting. One answer is to create a more equal tax across the board. Thomas Holmes, economics professor at the University of Minnesota, maintains that "it can be shown that the optimal tax (the tax that distorts [decisions] the least) is the one that is uniformly applied to all businesses." Incentives affect the economic decisions of companies. What might appear to be most efficient, and thereby most profitable in a free market, may be the wrong move after taxation is taken into consideration. So again we see the offering of incentives, in this case selective, or targeted tax abatements distort the efficiency that is the forte of the free market system.

The inefficiencies of the incentive system shown above are based on the assumption that businesses carry out their promise to "create" new jobs. More waste is introduced when companies dupe the government. The Charlotte Observer found several companies abusing the system in North Carolina. This End Up, a furniture manufacturer, received $230,000 and other incentives upon opening a new plant "creating" 200 new jobs. Weeks later it closed a plant in a nearby city employing 150. Similarly, Quaker Oats received $98,000 for opening a new factory and employing 98, and shortly thereafter closing a close by plant employing 70. Other problems arise when companies, like Sheffi Industries, which received $300,000 for 300 new jobs, go out of business-in this case only two months later, before hiring a soul, or even breaking ground. Cases such as these show that incentive programs leave much to be desired even beyond their theoretical causation of inefficiency in the marketplace.

States have begun to curb such blatant abuse of incentives by adding clauses in contracts which mandate that the businesses live up to their commitments. The clauses, or "clawbacks," allow the state to maintain some check on the subsequent actions of businesses receiving incentives. Economic development specialists hope that such precautions will make businesses more accountable to the government. The Minnesota Supreme Court heard a case surrounding a clawback clause when a private company that received funds to obtain capital goods tried to move to a new location—with the equipment, of course. The city of Duluth sued the company—and won. But proponents of incentives still fail to realize that, even if all incentives offered to businesses are protected from blatant misuse by clawbacks, incentives still are a zero-sum game, at best, for the overall economy.

Eliminating incentives will serve to increase efficiency on a state, national and global basis. We all benefit from greater efficiency in use of our natural resources. It means increased trade, greater productivity, economic growth and, most importantly, a higher standard of living for all—locally, nationally and globally.

In September of 1995 over 100 eminent Midwest economists signed a Joint Resolution on State Economic Development Policy urging states to abandon incentive offerings. The economists point out that the current system is at best a zero-sum game. Rob Kreibich, state representative to the 93rd Assembly District of Wisconsin, wrote to me that simply halting such programs in our state alone would put "Wisconsin... at a great disadvantage compared to other states." Some suggest that the governors of each state must unite and attempt to add a clause to each state's constitution.

James Madison recognized the problems resulting from the lack of economic unity among the states, and added the Commerce Clause to the Constitution. This gave Congress the power to end the economic war among the states as we know it. Ohio Sen. Charles Horn, along with Burstein and Rolnick of the Federal Reserve Bank of Minneapolis, seeks congressional action to stop current practices. Rolnick and Burstein write, "Congress could impose sanctions [against] states engaging in such competition." An end must come to the current wasteful practices, and it seems that only Congress, with power granted by the Framers in the form of the Commerce Clause, can provide a functional solution.

The economic war among the states is providing corporate welfare. Incentive programs may seem to have short-term, local benefits, but represent a general drain on government's revenue that should be used for public goods. These programs promote inefficiency in that they interrupt a fundamental advantage of the free market system, leading the private sector to avoid advantageous decisions for the benefit of all. The practice of offering incentives to businesses must end, and Congress has the power to end it.

Bibliography

Berliner, Michael S. "RE: State Wars." Personal E-mail Address (February 19, 1997).

Binswanger, Harry. "RE: State Wars." Personal E-mail Address (February 14, 1997).

Burstein, Melvin L. and Arthur J. Rolnick. "Congress Should End the Economic War Among the States." The Region: Federal Reserve Bank of Minneapolis 1994 Annual Report Volume 9, Number 1, March 1995: 2-20.

Burstein, Melvin L. and Arthur J. Rolnick. "Congress Should End the Economic War for Sports and Other Businesses." The Region: The Economic War Among the States June 1996: 35-36.

Farrell, Chris. "The Economic War Among the States: An Overview." The Region: The Economic War Among the States June 1996: 4-7.

Fettig, David. "A Report From the Battlefield." The Region: The Economic War Among the States June 1996: 9-19.

Grunewald, Rob: The Federal Reserve Bank of Minneapolis. "1996-97 Student Essay Contest: Should states be permitted to use targeted incentives to recruit businesses?" 1996.

Holmes, Thomas J. "The Effects of Tax Discrimination When Local Governments Compete for a Tax Base." Federal Reserve Bank of Minneapolis Research Department Working Paper 544 (1995).

Humphrey, Hubert H. Institute of Public Affairs. "Noticeboard for Economic Development Strategy Workshop." 1996. Http//www.hhh.umn.edu:80/Atrium/PA5592/ (and sub/branch directories) February 11, 1996.

Kreibich, Rob. "personal letter from state representative to the 93rd Assembly District of Wisconsin." February 21, 1997.

Mattey, Joe, and Mark Spiegel. "On the Efficiency Effects of Tax Competition For Firms." The Region: The Economic War Among the States June 1996: 50-5 1.

Meyers, Mike. "Ban urged on states' financial competition for businesses." Star Tribune November 26, 1996.

Minnesota Public Radio Online. "The Economic War Among The States." 1996. Http://www.mnonline.org/mpr/civic/econwar/ewintro.cfm (and sub/branch directories) February 11, 1997.

"Policy Proposals: Suggested by attendees at "The Economic War Among the States" Conference Washington D.C., May 1996." The Region: The Economic War Among the States June 1996: 14.

Reed, Lawrence W. "Time to End the Economic War between the States." Regulation-The Cato Review of Business and Government Issue 19 Article 2.

Reich, Robert B. "Bidding Against the Future?" The Region: The Economic War Among the States June 1996: 26-30.

Spicer, David Eddy. "North Carolina and the Battle for Business: A Case Study in Public Policy." 1996. Http://ksgwww.harvard.edu/battle/index.cfm (and sub/branch directories) February II, 1996.

U.S. Constitution. Article I, Section 8 clause 3 ("commerce clause").

Interviews

Craig Carlson, Eau Claire Chamber of Commerce Industrial Board.

Thomas Mihajlov, Firstar Bank of Eau Claire and Eau Claire City Council.

Mike Schatz, City of Eau Claire Industrial Planning Board.

 
Latest Articles
Related Links
Federal Reserve Consumer Help