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Policy Innovation Memo: How to Stop the State Subsidy Wars

by Edward Alden
May 12, 2014

A Tesla Motors Inc Model X is seen at Tesla's introduction of its new battery swapping program in Hawthorne, California (Lucy Nicholson/Courtesy Reuters).


The Renewing America Initiative is releasing today our new Policy Innovation Memo “Curtailing the Subsidy War Within the United States,” which I co-authored with Associate Director Rebecca Strauss. The problem is a vexing one. Governors and state governments quite rightly spend an enormous amount of time and energy trying to attract job-creating investments to their states. They think about how to get the right mix of tax policy, education, infrastructure and sensible regulation that will draw business to their states. They compete vigorously with other states, and other countries, to sell companies on the merits of locating in their state. All of this deserves applause.

But sadly, that is rarely enough. Companies, especially large ones, are quite capable of playing states off against each other to extract millions in taxpayer dollars. Boeing, Caterpillar, Toyota and most recently the electric car maker Tesla are just a few of the companies that have played this game with great success. And so state governments are forced into bidding wars, offering special tax breaks, gifts of land or other subsidies to persuade companies to choose their state over others. It is a racket that costs states about $80 billion a year, which amounts to roughly seven percent of total state budgets. As Becky and I wrote in a New York Times op-ed that appeared on Saturday: “From a national perspective, this is about as dumb as it gets. Taxpayer money is wasted to pay off companies that would most likely have invested somewhere else in the United States.”

Figuring out what to do about these bidding wars is a whole lot harder. The easiest solution would be for the federal government simply to ban such subsidies. As one correspondent put it to me after the NYT article appeared: “Your op-ed takes the long way ‘round.” There is a solid legal argument to be made that Congress has the constitutional authority to forbid state subsidies, and current practices may well violate the Commerce Clause. The European Union, which in most respects is much less centralized than the United States, has a “State Aid” law that severely restricts the sort of subsidies that members states like France and Germany can offer to companies.

Sadly, after considering these options, we concluded that however strong the legal case for federal pre-emption, the political likelihood of this happening in Congress as it is currently configured is about one-in-a-bazillion. For purposes of economic development, U.S. states these days are almost like independent nations, with the federal government doing little or nothing to stop states from bidding freely for business. So, much like independent nations, states will only end the handouts if they voluntarily see the benefits of cooperation.

That is what made us look at international models of cooperation, such as those in the World Trade Organization (WTO) and the Organization for Economic Co-operation and Development (OECD). Surely if sovereign states can see a collective interest in rules that restrict subsidies–however imperfectly they are enforced–then U.S. states should be able to do the same.

Our report sketches out a model for how this could work, starting with greater transparency on what states are currently spending, and building up to regional pacts in which states agree to curb their subsidies if others do the same, while remaining free to compete with other states that refuse to abide by the rules. We suggest several ways the federal government could help. We do not underestimate the difficulty of this. It will take political courage for state leaders to take the first step. It will involve complex negotiations. Subsidies are not always easy to define, and some subsidies–say community college training geared to the specific needs of a large employer–are clearly desirable. And it could easily fail–a similar push in the early 1990s by Illinois governor Jim Edgar came to naught.

But the alternative is continue large and wasteful subsidies that are likely to become even larger and more wasteful. As we put it in the NY Times piece: “The only way for states to stop corporations from playing divide-and-conquer is to figure out ways to work together.”

Post a Comment 5 Comments

  • Posted by Kenneth Thomas

    Perhaps inter-state agreements should start even smaller than you suggest. Instead of addressing all location subsidies, they should just ban subsidies for the relocation of existing firms. Of course, even those have failed in the past, but they are the easier to show as harmful than bidding wars for new investment are. Maybe we are in a period that is more open to actually doing something about this issue.

    Thanks for putting these suggestions out there.

  • Posted by Johnny

    Our spending is out of control, which causes our taxes to be out of control. Taxes in most states are higher than in other countries. If you don’t allow state negotiation, then big companies are going to go to states that have no corporate income tax or worse go to other countries. You’re trying to protect some dollars of subsidies and end up losing millions of jobs.

    We advocate free market but when companies play the game of supply and demand with our government, we don’t like it. Everyone enters in a deal because they have something to gain. No one ever enters a deal knowing they have more to lose than to gain. So if it benefits everyone, I don’t see what’s wrong with it.

  • Posted by Kent Oelkers

    Is it safe to say that you have never truly worked in private sector producing nothing more than hot air?

    What will it take for us all to understand the Federal Government is not, repeat not the answer, and neither is your solution.

    If it were not for the states being aggressive, do you really think those jobs would stay in the states…who is kidding who?

    Suggestion, OPEN YOUR EYES…

    God Bless

  • Posted by Richard Viktorin

    Who would have guessed that the most cogent paper on this topic, the business location incentives war, would come from the Council on Foreign Relations? Yet it is from the perch of international trade and trade agreements that one sees most clearly the folly and hypocrisy at home. We expect behavior from our international trading partners that we are unable to obtain from our own political subdivisions, our un-united states as it were, and which is the current state of affairs on this topic.

    Corporate incentives corrupt both markets and political economies. Most significantly, public treasuries fall victim as corporate MBA’s prey on hapless and ill equipped bureaucrats. Having witnessed it from the front lines, if feels remarkably similar to a streetside shakedown.

    Here in Texas, a governor, Rick Perry, has used a corporate sponsored economic development organization, Texas One, to finance the road show for his presidential aspirations. And in another instance, Texas legislators modified a tourism program to make it a candy jar for crony pork and sports entertainment finance. This was how Texas built the billionaire and auto magnate, Red McCombs, his Formula One race track known as the Circuit of the Americas in Austin.

    In reading this report, one can note Richard Haass and his inward gaze toward the domestic as the place for solutions to the problems America faces abroad, none more so than in the arena of economic competitiveness. Mr. Haass’s sentiments echo in this report. Is America better off when states empty public treasuries into corporate coffers rather than, for instance, into education? After all, in an ever advancing and technical world economy, it is our human resource, not guns or geography, which will be our economic and international strength. It is from a position of strength that we are most able to protect and project our values in the arena of world affairs.

    In the race to the bottom that is our states’ corporate subsidy war, we are not better off, not only to ourselves, but neither to the world. In the end, location incentives, as to our common and shared national summation, will diminish both the democratic yield and the market yield from the American enterprise. The public interest is not well served by the current regime.

  • Posted by Billy Jones

    Indeed, this very same argument, everywhere you wrote “states” could just as well be cities, counties and other municipal governments as well. Here in North Carolina and other states cities pay incentives to steal jobs from other nearby cities often as close as the next county line.

    There can be no advantage to this behavior.

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