Jul 27, 2018

Why Do Politicians Push for Corporate Welfare?

Matthew D. Mitchell Interviews Authors of a New Book on Targeted Economic Development Incentives
Matthew D. Mitchell Senior Research Fellow , Nathan Jensen, Edmund Malesky

Nathan Jensen (professor of government at UT Austin) and Edmund Malesky (professor of political science at Duke) have just published a new book on targeted economic development incentives. It is a penetrating investigation into an increasingly important topic. I sat down with Professor Jensen and Professor Malesky to learn a little more about their work.  

Matthew Mitchell: Can you explains the basics of your book?

Nathan Jensen: We study the politics of economic development incentives. Incentives include tax holidays, cash grants, infrastructure improvements or other firm-specific benefits. We stress that these are for a single firm, and not a tax cut or infrastructure improvement that benefits the whole business community. These are special deals for a single company to encourage relocation, expansion, or retention.

We show that most of the existing research points to these as very expensive (as much as $80 billion a year in the US alone) and ineffective. We then ask the question: “Why would politicians use such ineffective policies?” Our answer is that they use them to take credit for investment coming into their district. We use survey data and data on incentive use to demonstrate that politicians can use these programs for political gain.

MM: But what about the role of campaign contributions or special interests in the political process?

Edmund Malesky: Our study by no means discredits the role of special interests. What is interesting to us is that, in many cases, this is a very public handout to a single company, not a briefcase full of money exchanged behind closed doors. Special interests shape the design of these programs and can influence incentive decisions. For example, Wisconsin has had a number of recent economic development scandals that have linked campaign donors to sweet incentive deals. 

Our point is that even without these special interests, politicians are motivated to provide these incentives for electoral gain.

MM: Your book cover has a picture of President Trump in front of a Carrier Factory in Indiana. Does this mean that Republicans are more likely to provide incentives?

EM: No, Republican and Democratic politicians are equally likely to use them.  But in fact, Republican voters appear more likely to doubt their benefits. For the cover, we wanted a picture of a politician beaming in the glow of a recent incentive allocation.

We picked this picture because it is a perfect example of a politician announcing an economic development incentive and claiming that it will save a company from leaving Indiana for Mexico. Sadly, most of these jobs have left Indiana anyway, but not before a great photo op.

Our second choice was a picture of then-Democratic Governor of Virginia, Terry McAuliffe. This picture showed him literally handing a huge check to a group of Chinese investors. This turned out to be a scandal, where the company made a fake website and the state didn’t conduct basic due diligence on what became a failing company.

MM: Is there anything that would surprise our readers about these programs?

NJ: What has surprised us is how many states have conducted audits or an analysis of their own economic development programs that recommended major reforms or the elimination of these programs. This ranges from a program centered on rural development in Alabama (their CAPCO) program, to California’s flagship economic development program. State evaluations of film incentives have been especially devasting. Virginia found that for every $1 of film tax credits, only 20 cents is returned to taxpayers.

This ineffectiveness is an open secret. Readers should Google their own state name and “economic development incentive evaluation.” The evidence is stunningly clear.

MM: If these programs are so inefficient, who supports them?

EM: In our book we document a fight over the transparency of economic development incentive programs. A recent decision by the Governmental Accounting Standards Board (GASB) requires governments to disclose how much tax revenue they lose due to tax abatements every year.

This led numerous groups to oppose this new transparency rule, including economic developers, law firms, and industry associations. This isn’t a surprise.

We think this is a good illustration of who supports these programs. Large business associations as well as local Chambers of Commerce are often the most supportive of these programs in general. However, there is a whole cottage industry that has developed around these programs from economic developers, consultants, lawyers, and even financial institutions that specialize in buying and selling the tax credits.

MM: Is this only a US problem?

EM: No, in our book we document incentives around the world. The US differs a bit from other countries in that most of our targeted economic incentives are provided at the state and local level, whereas many other countries have strong national economic development promotion agencies. Many incentives in the US are offered to companies that are looking to relocate from one state to the other, which is less likely in countries where economic development policy is conducted at the level of the central government.

In many places, we also see rules limiting the use of incentives. In Brazil, there have been a number of attempts, with limited success, to limit incentive competition across states for investment. In the European Union they have limited this incentive competition with “state aid” rules.

We show that even in non-democratic regimes we see the use of incentives for political gain. In Vietnam, we find that subnational leaders also provide incentives to firms, often to show party leaders that they are successful in attracting investment and worthy of promotion. We find that when leaders are at mandatory retirement age (and are therefore no longer promotable) they provide far fewer incentives.

MM: What can we do about this problem? Does providing more information to the public about the size of these programs work?

NJ: As you know, last year Amazon announced plans for a second headquarters that could amount to $5 billion in investment and 50,000 jobs. Cities and states are throwing billions at Amazon for this competition and it is unclear which of the twenty finalists will land Amazon HQ2. Many local groups are very upset about the secrecy of this process. But surprisingly, there isn’t a lot of public outrage over the billions in incentives being offered. If anything, politicians can use these offers to “show” that they are the reason that Amazon came to their state.

But our research suggests that the sticker price has little impact on public opinion. However, when the costs are presented in terms of tradeoffs, such as increased taxes or reduced spending on education, the political benefits of incentives evaporate. For example, your own estimate that Wisconsin could have reduced its corporate income tax by 21 percent instead of handing over billions to Foxconn is really stunning.

So, one strategy for reform is to make these opportunity costs clearer to voters. Incentives may help generate some jobs, but are they worth the additional costs to individuals and businesses? More precisely, are the tax abatements for companies worth reductions in funding for our schools or tax cuts for all?

MM: Thank you for your time today. Nate and Eddy’s book is called Incentives to Pander: How Politicians Use Corporate Welfare for Political Gain. If you’d like a short preview of this work, check out their video:

 

Photo credit: JEFFREY PHELPS/EPA-EFE/Shutterstock

Support Mercatus

Your support allows us to continue bridging the gap between academic ideas and real-world policy solutions.Donate