Civil War, Round Two

Barron's
April 3, 1995

As states fight one another for car factories, casinos and sports teams, common sense has gone out the window. Should Uncle Sam step in?

by Andy Zipser

Putting a Mercedes in your garage is easy. Paying for it is the hard part. That's what the state of Alabama is just now finding out. Last year, when the Camellia State was selling itself to Germany's Daimler-Benz as the ideal site for the company's first American auto plant, $253 million in direct aid and tax incentives seemed a small price to offer. After all, Daimler was promising to bring luster to long-depressed Alabama by turning out fleets of four-wheel-drive luxury vehicles bearing the Mercedes nameplate, and more important, the new factory would employ 1,500 workers. But on April 1, just when Alabama was supposed to cough up $40 million to get the project rolling, the state's general fund was several million dollars in the hole and the promised cash simply wasn't there.

April Fool, Herr Daimler.

Alabama officials say they will manage to come up with the money. But in the long run, the joke could be on them.

This assertion may sound like heresy to many governors around the nation, not to mention their increasingly numerous and increasingly assiduous promoters of "economic development." These boosterish bureaucrats eagerly chase enterprises ranging from the New York Yankees to Nucor steel plants to Disney theme parks. In theory, getting such operations to locate in a given state has a ripple effect, attracting scores of suppliers and other businesses. More jobs, more money, more tax revenues. In Alabama, for example, the hope is that Daimler can ignite an industrial rejuvenation, ultimately giving taxpayers a return on their investment of better than 50%.

Only now, as Alabama scrambles to come up with the cash, are the flaws in that reasoning becoming glaringly apparent. The Midwest Center for Labor Research, for example, has concluded that the state inflated virtually every assumption it threw into its cost-benefit analysis, from the multiplier used to calculate the plant's ripple effect to the amount of equipment Daimler will be able to buy within the state to the annual sales—and therefore annual tax payments—the plant will generate. The bottom line? Alabama's state and local governments won't recoup up-front expenses for a minimum of seven years, while Daimler will continue to pay lower taxes than other businesses in the state for years thereafter.

After decades of doling out generous inducements to various industries, some states are coming to realize that taxpayers often get the short end of the stick in these deals. Yet most state officials can't seem to help themselves. For a politician, delivering jobs is irresistible—at any cost. Thus, it should come as no surprise that Alabama is, in effect, paying about $168,000 for every job at Daimler.

Other acts of desperation include the town of Deadwood, S.D. (pop. 1,200), throwing $7 million at actor Kevin Costner to build a casino; New York ponying up $362 million in just one year to keep four companies and five commodities exchanges from jumping to New Jersey or Connecticut, and St. Louis recently mounting a preposterous effort to woo the Los Angeles Rams.

High-cost incentives, low-wage jobs

Then there was South Carolina paying an estimated $150 million to land a BMW plant in 1992, Utah more recently coming up with an estimated $200 million to land Micron Technology's new semiconductor plant, and Virginia's plan, derailed last year, to give Walt Disney Co. a $163 million package of incentives to build a Civil War-themed playground not far from the real thing at Gettysburg. In return, Virginians would have seen the creation of 2,700 "equivalent" full-time jobs. Seventy percent of those "equivalents," however, would have been part-time and seasonal, paying less than $10,000 a year and offering no health benefits.

Other deals fall little short of bribery, such as the $240 million— including free land and state-paid employee retraining—given to Sears Roebuck by Illinois to keep the retailing giant from leaving the state. And consider just some of the "Terrible 10 `Candy Store' Deals of `94," recently compiled by Chicago-based consultant Greg LeRoy:

When Briggs & Stratton decided to move roughly half of its Milwaukee-area jobs to Mexico and a handful of Southern states, the federal government agreed to subsidize two of the U.S. sites with a combined $855,000 in taxpayer funds. A storm of protest from Wisconsin killed a major part of the deal, but still rewarded the world's largest maker of small engines with more than $200,000.

Taking advantage of Louisiana's economic development programs designed to reward companies for creating jobs, Exxon filed 28 tax-abatement applications totaling more than $14 million—but because of its use of out-of-state labor, it projected creation of only one new, permanent job. Not that Exxon was doing anything unusual: According to the Louisiana Coalition for Tax Justice, nearly 75% of the state's property-tax exemptions go for projects that create no new permanent jobs.

After Michigan provided $81 million in incentives to build a paper-recycling mill, Blue Water Fibre used out-of-state contractors for the vast majority of its construction work force. Worst of all, the completed plant will employ only 34 permanent workers. That translates to a state outlay of more than $2 million a job.

"I think it's nuts—just nuts," says LeRoy. And from a nationwide perspective, it's bad public policy, a zero-sum game that simply transfers wealth from the great mass of taxpayers to a relatively small group of companies. A particular state may "win" in the near term, but long-term, all suffer.

A new approach begins to emerge

Some savvier development officials nowadays are beginning to call for a new approach, one that focuses on industries rather than specific companies and that tries to create an irresistible environment that meets industry needs. In effect, "if we build it, they will come."

One proponent of this approach is Wayne Fawbush, a principal architect of Oregon's sophisticated recruitment program. Says he, "The more you compete for a business, the more you look like your competitors." Fawbush will forgo industries that are paying minimum wage for work, especially ones that might be better off hiring people in low-wage countries much as Indonesia or Romania.

Oregon's economic development program starts with three basic notions: that some jobs aren't worth having, that lasting economic development can occur only in the context of community development, and that any development plan worth its salt must have measurable benchmarks. All three points, alas, are rarely appreciated: When Fawbush recently outlined Oregon's development program to a group of journalists at the University of Maryland, Virginia's economic development director, Wayne Sterling, rolled his eyes, shook his head in mock despair and sighed heavily. "My job is to get jobs," he later told the group. "We're salespeople."

Yet, as Fawbush notes, "For every low-wage job you create, you create a liability." In Oregon in 1991, for example, a family had to have an annual income of $32,000 for the state to break even: In other words, families earning less than $32,000 a year paid less in taxes than they consumed in state services. Assembly-line jobs at $7 or $8 an hour—as up to half of the 3,500 jobs Micron will create in Utah will be paying—just won't cut it, according to this reasoning. Not when the state is buying them at a cost of tens of thousands of dollars apiece.

But high-paying jobs don't exist in a vacuum, either. They require an educated work force, a well-developed infrastructure, a diversified economic base—all the kinds of things, says Fawbush, that call for investing in the state's own resources. To assure that such aspirations don't become unattainably abstract, Oregon also has adopted a system of 259 "benchmarks" to measure its progress on everything from public safety to housing quality to economic diversification. The overall goal, says the plan, is "a state of well-educated, competent people living in thriving communities, working in a well-paying competitive economy, and enjoying a pristine environment."

Oregon is very much in the minority, however. Elsewhere, one reform effort after another has crumbled. Take the 1986 Commission on the Future of the South, for example, an assemblage chaired by a bright-eyed Arkansas governor named Bill Clinton and charged with the task of figuring out "what is it going to take for the South to reach economic parity with the rest of the United States?" The answer was a set of 10 recommendations, four of which dealt directly with education and only one that touched on economic development policy.

Has Bill Clinton forgotten his role?

Nearly a decade later, Bill Clinton no longer provides regional leadership on such issues and the economic well-being of most of the South remains bleak. "Some things die hard. Some people are real stupid," says former commission member J. Mac Holladay, now an economic-development consultant to the Kettering Foundation, when asked about the Alabama-Daimler deal.

Yet Alabama moves on, currently wooing a $450 million steel minimill, to be built by a new partnership of LTV, Sumitomo and British Steel, despite threats of lawsuits by steel-making competitors, and a $200 million chemical plant expansion proposed by Amoco. Memphis is competing for the mill, Charleston, S.C., for the chemical plant, but—as usual—the details of how each state is willing to mortgage its future won't be disclosed until long after the deal is clinched, and then only by the winner. The losers will shield their cards until the next go-round.

(Win or lose with Amoco, Charleston already notched a significant victory in the economic development wars in early March, edging out Virginia in a months-long battle for a $500 million Nucor minimill. Cinching the deal was a new law, passed specifically to meet Nucor's "needs," that gives the steelmaker a break on its electric bill. Nucor gave South Carolina the nod less than 24 hours after its governor signed the bill.)

It doesn't take a lot of smarts to figure out that this is an undesirable state of affairs. Governor after governor deplores the downward spiral on which he finds himself—then turns around to cut yet another deal. Editorial writers galore weigh in with their own jeremiads—then trumpet each new industrial coup. Think tanks like the Washington, D.C.-based Corporation for Enterprise Development prescribe reams of remedies, from codes of conduct to disclosure requirements to taxpayer lawsuits—much of it instantly forgettable. The war among the states has taken on a life of its own, evolving into a decades-long grind that squeezes the juice out of its critics' passion and reason.

Yet bleak as that sounds, there may be a relatively simple way out of this mess—a way first shown more than two centuries ago, when the 13 original states were mired in a bitter trade war. Although the Articles of Confederation had created a political union, they didn't preclude erection of tariffs and other economic barriers among the states. Fearing their union was about to disintegrate, the states dispatched representatives to Annapolis in 1786 to amend the articles, but soon realized the problem was too complex for such bandaid remedies. The result was a full-blown constitutional convention, at which James Madison responded to the economic crisis by crafting the Commerce Clause, giving Congress the power to regulate "Commerce ... among the several States."

Now the Federal Reserve Bank of Minneapolis is suggesting it's time for Congress finally to exercise that authority. In its annual report, issued last week, the bank's general counsel, Melvin Burstein, and director of research, Arthur Rolnick, argue that economic warfare among the states is harmful to all, that the courts are unable to remedy the situation and that Congress must seize the initiative.

"Only federal legislation can prevent states from using subsidies and preferential taxes to attract and retain businesses," they write. "The states won't end this practice on their own" because "as long as a single state engages in this practice, others will feel compelled to compete."

Calls for Uncle Sam to become involved in trade issues may seem odd, especially as trade barriers throughout the world are falling, thanks to NAFTA, the World Trade Organization and various regional free-trade agreements. Yet free trade flourishes only on a level playing field, and the use of taxpayer dollars to selectively subsidize private industry creates as many dips and folds in that field as any tariff. If Mercedes gets a tax break, Rolnick argues, then all companies in Alabama should get exactly the same deal.

"They always talk about the jobs and the multipliers, and I always say `But isn't that true of all companies?'" Rolnick observes. "Don't they all bring jobs? Don't they all have multipliers? So where do you draw the line?"

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