Robert VerBruggen draws on a new Mercatus Center working paper (“The Political Economy of State-Provided Targeted Benefits“) to make the case against state and local efforts to lure businesses to their jurisdictions. States and cities tend to exaggerate the value of targeted benefits, as it is difficult to discern which share of economic activity was generated by the benefit in question and which share would have been generated even in its absence, or under some policy regime that was neutral across firms. Moreover, targeted benefits contribute to the misallocation of resources, as firms would base their decisions on economic fundamentals in their absence rather than on the extent to which they can extract subsidies. The authors of the Mercatus paper, Christopher Coyne and Lotta Moberg, conclude by calling for a generality norm, in which “no company or industry receives preferential treatment over others.” I agree with them on all counts.
David Schleicher has addressed the tension between sorting, in which households and firms choose among competing jurisdictions, based on the quality of public services and taxes, the gains from agglomeration, i.e., the tendency of households and firms to locate themselves near other households firms to take advantage of the lower transportation costs, intellectual spillovers, and labor market depth afforded by dense living. Defenders of high-tax state and local governments will often observe that high taxes in California, New York, and New Jersey haven’t led to a mass exodus of high-earning households and productive business enterprises. But of course this reflects that, as Schleicher argues, “the existence of agglomerative gains means that individuals are making location decisions for reasons other than matching their preferences for public policies.” Conversely, if all jurisdictions across the country imposed the same taxes and regulations, it is easy to imagine that many households that have left densely-populated coastal metropolitan areas in search of affordable housing, and many firms that have left these regions in search of a less burdensome tax and regulatory climate, might have remained in these regions.
Suffice it to say, we’re not about to impose the same policies across all state and local governments, nor should we do so. We can, as Coyne and Moberg suggest, move towards a world in which state and local governments compete not by offering targeted benefits, and thus allowing large business enterprises making location decisions to essentially prey on vulnerable jurisdictions, but rather by offering a more attractive business climate to all firms. Agglomerative gains will still mean that regions that aren’t already dense hubs of activity will have to try harder than those that are, but that’s not new, and it might even be a good thing insofar as it stimulates policy creativity. And though agglomerations are durable, new ones do emerge from time to time. Texas’s attractive tax and regulatory climate has contributed to rapid expansion of metropolitan areas like Austin, Dallas, and Houston, which are increasingly able to compete with other dense regions for talent. This puts constructive pressure on the dominant regions. No, there is no single tax hike that will cause New York city or Los Angeles’s advantages to vanish overnight, but over time, bad policy takes a toll and creates an opportunity for competitors.
So how do we see to it that jurisdictions compete constructively (by offering a more attractive tax and regulatory climate for all households and firms) and not destructively (by engaging in a beggar-thy-neighbor competition to offer targeted benefits)? There have been some efforts to limit targeted benefits on the grounds that they cut against the dormant Commerce Clause, i.e., they interfere with the free flow of interstate commerce, but these arguments haven’t gained much traction. Edward Alden of the Council on Foreign Relations offers a series of recommendations for curtailing what he calls the “subsidy war” within the U.S., including: (a) having the federal government require that state and local governments report all subsidies to a federal data warehouse; (b) having state governments require cost-benefit analyses for all business subsidies above a threshold; and (c) encouraging states to form compacts to limit subsidies, starting at the regional level.
I’d love to see conservative governors and lawmakers take the lead in forming regional anti-subsidy compacts, particularly in regions like the Deep South and the Mountain West. Elected officials in these regions can make a credible case for creating business-friendly climates while swearing off targeted tax breaks, and a willingness to avoid targeted tax breaks would demonstrate their pro-market, as opposed to pro-business, bona fides.