1996-1997 Essay Contest

Second Place Essay

Brereton's Folly

Robert Giampietro
Edina High School
Edina, Minnesota


Economists seldom agree about anything, but in 1930, they did: over 1,000 professional economists wrote to President Herbert Hoover urging him to veto the Hawley-Smoot tariff. They claimed it would be disastrous for the national economy, and they were absolutely correct. Which is why, now over 60 years later, when 100 midwestern economists wrote a joint resolution calling for an end to the "economic war among the states," legislators sat up and took notice ("100 Midwestern Economists ... 11). In their proposal, the economists stated six truisms about the economic war that fall into two general categories: 1) Competition among states for specific firms results in a distorted free market, and 2) Targeted incentives do not create new jobs or businesses; instead, they simply move them from state to state in a "zero-sum" game, which becomes "negative-sum" when the state incurs a diminished production of public goods and development of vital infrastructure as a result of the incentives. Therefore, states should not be allowed to use targeted incentives to recruit new businesses.

Competition for specific firms distorts the free market in several ways. In 1979, Volkswagen was offered a $71 million incentive package to locate its new plant in Pennsylvania. In return, the company promised to create 2l,000 new jobs. Within a decade, Volkswagen closed the plant, which had never employed more than 6,000 people. ("Congress Should End the Economic War among the States"). But the taxpayers of Pennsylvania were not the only ones who financed Volkswagen's now-famous sour deal. The deal also penalized existing businesses with higher taxes to compensate for the reduced taxes on Volkswagen. The practice is common, making it tremendously difficult for penalized firms to compete. Two firms with like products and similar costs may face very different tax bills. Sam Stanley of Ohio's Buckeye Institute observes, "in Ohio, assistance goes to firms willing to locate in the state. Meanwhile, loyal Ohio businesses subsidize these competitors through higher taxes" (100 Midwestern Economists...).

This playing field, skewed toward out-of-state firms, is unfortunate because most jobs are created by firms within a state. In Ohio, 78% of new jobs created in 1993 were created by local firms. In some areas, that number is over 90% (Reed). Melvin Burstein and Arthur Rolnick of the Federal Reserve Bank of Minneapolis cite that "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" ("Congress Should End the Economic War Among the States").

Targeted incentives certainly are not an example of these "optimal taxes." Again in Ohio, the state offers incentives to about 350 businesses per year, or less than 0.5% of the 100,000 growing businesses in the state ("Tax Giveaways..."). Not only are targeted incentives not uniformly applied, they seem to be awarded to an alarming number of large firms, who demand bigger dollars. Colorado Gov. Roy Romer explains, "if someone comes in here and says he is going to create 600 jobs at $6 an hour, . . . let those jobs go to Missouri" (Vogrin). In "I-ax Giveaways to Entice Business Backfire on States,"USA Today also points out the trend toward large firms, but concludes "large firms are the weakest job producers. Finns with fewer than 20 employees produce three times the job growth of those with more than 500 employees." The article continues to cite eight such large firms, who commanded an average incentive plan of $176 million.

Many times, firms are able to command astronomically high incentives like those cited by USA Today by playing one state off another, often at a dramatic cost to the states. Mercedes-Benz groused several hungry Southeastern states for the best possible deal and came away with a doozy: $300 million from Alabama, including a $5 million welcome center for visitors to the plant. Meanwhile, the state was under judicial mandate to spend hundreds of millions on its ailing public school system. In the end, the 1,5 00 jobs the Mercedes plant created were created at a loss (Mahtesian).

This phenomenon is know as the "winner's curse": in an auction with many bidders the winner is often the loser (Farrell). Many times, after the smoke from the bidding war has cleared, states are left with few rewards for their huge benefit packages. Targeted incentives do not create jobs; rather, they simply shift jobs that would have been created regardless from state to state, causing states to spend vital infrastructure funds needlessly in a foolish game of beggar-thy-neighbor. The city of Cleveland, struggling to keep from losing the Browns, offered to spend $175 million for a new stadium in 1995, yet in the same year closed 11 schools due to lack of funding ("Congress Should End the Economic War for Sports and Other Businesses"). A 1989 report from the Council of State Governments emphasized that "a comprehensive review of past studies reveals no statistical evidence that business incentives actually create jobs ... [T]hey do not have a primary effect on state employment growth." The report goes on to say that "[incentives] are not the primary or sole influence in corporate decision-making" (McEntee).

Incentive programs are in fact a minor factor in plant location decisions for most firms. A 1993 survey by the International Association of Corporate Real Estate Executives and the American Economic Development Council surveyed 800 corporate real estate executives who rated incentive programs 14th out of 17 factors that influence site decisions. Only 23% of those surveyed characterized the programs as "important" (Reed). Mark Klender, a Senior Manager in the Deloitte & Touche Realty Consulting Group advises, "companies should not be weighing incentives heavily—if at all—in the early stages of the selection process. Make sure the community works from key operating cost and condition perspectives." David Birch, Anne Haggerty, and William Parsons agree. As the authors of Entrepreneurial Hot Spots: The Best Places to Start and Grow a Company, 1995, they concluded that what matters to businesses is a skilled labor pool, a few good universities, a major airport, and a good quality of life (Farrell). In other words, infrastructure matters, and the higher the bidding war pushes prices, the less money states have to pump into exactly what matters to businesses the most.

"Economies," according to Irving Kristol "aren't machines to be fine-tuned. They're more like gardens to be watered and tilled." Indeed, the use of targeted incentives to recruit businesses is more tinkering than tilling. It is a short-term solution for a long-term issue: how best to grow state economies. With a tax rate twice as high as its neighbors, and having just committed to a $140 million incentive plan with Dofasco/CoSteel designed to create only 400 new jobs, Kentucky's Governor Brereton C. Jones said, "incentives can be an effective means to an end." Incentives are not an effective means to an end; instead, they need to end. Only then can states like Kentucky stop senselessly investing huge dollars in small 400-person plants and start about the business of truly investing in their futures.

Bibliography

"100 Midwestern Economists Call for End to Economic War between the States." From Senator Charles Horn's homepage.

Burstein, Mel and Arthur J. Rolnick. "Congress Should End the Economic War Among the States." Federal Reserve Bank of Minneapolis 1994 Annual Report (1 March 1997).

---. "Congress Should End the Economic War for Sports and Other Businesses." From materials published at The Economic War among the States Conference, Washington D.C., May 21-22, 1996.

Edgar, Jim and Brereton C. Jones. "Point/Counterpoint." Originally published by Council of State Governments. March 1993.

Farrell, Chris. "The Economic War Among the States: An Overview." From materials published at The Economic War among the States Conference, Washington DC, May 21-22, 1996.

Fisher, Peter S. and Alan H. Peters. "Taxes, Incentives, and Competition for Investment." From materials published at The Economic War Among the States Conference, Washington DC, May 21-22, 1996.

Fulton, William "Costing out the Smokestack Chase." Governing Magazine. December 1996.

Mahtesian, Charles. "Romancing the Smokestack." Governing Magazine. 1995.

McEntee, Gerald W. "The Problem With State Bidding Wars and Some Possible Remedies." From materials published at The Economic War among the States Conference, Washington DC, May 21-22, 1996.

"No Proof Subsidies Create Jobs: Audit Rips State's Policies; Taxpayer Millions Untracked." Denver Post. February 1996.

Reed, Lawrence. "Time to End the Economic War between the States." Originally published by Mackinac Center for Public Policy (Michigan).

"Tax Giveaways to Entice Business Backfire on States." USA Today. 10 October 1995.

Vogrin, Bill. "Stop Using Incentives to Draw Low-Paying Jobs, Romer Urges." Colorado Springs Gazette.

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