Even Central Bankers Are Wary of
States' Tax-Break Frenzy

This document is available courtesy of the Lexington Herald-Leader.

Wednesday, March 22, 1995
Section: COMMENTARY
Page: A11
Bill Bishop Herald-Leader columnist

OK, so Congress sends blocks of money back to the states to take care of welfare, education, housing. What's the guarantee that money will go to the public good rather than private gain?

Money is fungible, right? A dollar for a school breakfast looks exactly like a dollar spent for a tax break. What's to stop a state from shifting its money around, short-changing public advancement while subsidizing private accumulation?

It's a real worry—and not just of some granny-gowned liberals. The shifting of money set aside for public good to private gain is a real worry of two top officials of the Federal Reserve Bank of Minneapolis.

In a clearly worded article due out in the bank's annual report (and released to journalists last week), two Fed officials argue that Congress should immediately halt the bidding wars between states for the location of business. This is particularly true now that Congress is set to shift large huge sum to the states, according to Melvin Burstein, the bank's general counsel, and Arthur Rolnick, its senior vice president and director of research.

"If you continue to allow states to compete" by giving tax breaks to individual companies, says economist Rolnick, "who knows where this (block grant) money will end up." Rolnick and Burstein suspect states will reduce the money they spend on education, roads, police, libraries and fire protection while increasing the kitties they use to attract industries looking for the cheapest place to set up shop.

Burstein and Rolnick have good reason for this suspicion. "Competition among states for new and existing businesses has become the rule rather than the exception," they write.

This competition has put a strain on the normal public business of the states. "While states spend billions of dollars to retain and attract business," Burstein and Rolnick write, "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."

Burstein and Rolnick are not against competition. (They are bankers, for goodness sakes.) When states compete to provide public goods (libraries, roads, etc.), the bank officials find this "leads states to provide a more efficient allocation of public and private goods."

That's not what's happening, however. States are opening their treasuries to private companies. Kentucky has offered tax breaks to individual companies amounting to more than $3 billion. Alabama has done the same thing (including one recent case where the potential tax liability comes to more than $3 million a job).

When this happens, Burstein and Rolnick write, "when that competition turns into preferential treatment for specific businesses . . . it interferes with interstate commerce and undermines the national economic union by misallocating resources and causing states to provide too few public goods."

These are not benign policies. The promises that these giveaways will buy prosperity are "snake oil," says economist Rolnick. Instead, he says, the tax incentive circus "distorts the location of business and it takes money spent for public good and spends it for private good."

The result, the authors say, is "generally harmful to the overall economy."

This is not what the Founding Fathers intended. The goal of the Constitutional Convention, says Rolnick, "was essentially to create economic union." The states (even then) were fighting. They erected trade barriers, distorting the natural flow of commerce. No state would unilaterally stop fighting these trade wars. It took a constitution to end the struggle.

Rolnick and Burstein believe Congress should act today much as the Constitutional Convention acted more than 200 years ago. The states won't stop this war by themselves. The courts will not intervene. "Only Congress has the power to enact legislation to prohibit and prevent the states from using subsidies and preferential taxes to compete with one another for business," the bank officers write.

And Congress should act now, before it dumps more money onto states that can no longer tell the difference between public purpose and private enrichment.

Copyright © 1995, Lexington Herald-Leader, all rights reserved.

 
Federal Reserve Consumer Help