December 7, 2016

Trump's Carrier Deal Won't Make America Great Again

Matthew D. Mitchell

Senior Research Fellow
Summary

America was made great by its commitment to the rule of law, to equal protection under that law, and to an open and level economic playing field. It would be great if someone remembered that.

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243 years ago next Friday, patriots crept aboard three ships anchored in Boston Harbor and chucked 342 chests of tea into the icy waters below. This quintessentially American protest was sparked by a quintessentially American concern: inequitable government policy. The colonists were infuriated by the British government's decision to grant a tax break to one-and only one-company: the East India Tea Company. Sound familiar?

It's noteworthy that before even taking office, President-elect Donald Trump has chosen to offer a tax break to one and only one company: Carrier Corporation. With an assist from Vice President-elect and current Indiana Governor Mike Pence, Mr. Trump worked out a deal to privilege the firm with $7 million in Indiana state tax breaks, paid out over 10 years.

The deal will not make America great again. In fact, it betrays an astonishing disregard for what made the American economy so great in the first place. Here are 10 reasons why:

1. Tax breaks cost the rest of us (more than you think). When one firm gets a tax break, everyone else's tax burden must go up, government services must go down, or both. Since every dollar that is taxed out of the economy reduces the size of the economy by more than a dollar (a phenomenon economists call excess burden) the real economic damage is likely to exceed the deal's modest $7 million budgetary cost.

If this type of deal becomes standard governing procedure, then the costs could be astronomical. As the University of Michigan's Justin Wolfers points out, in the two hours it took Mr. Trump to fly to Indiana to save some 800 jobs, about 6,000 U.S. jobs were destroyed. Marginal tax rates would skyrocket if we cut special deals to try to preserve each and every one of these jobs.

2. Subsidies diminish dynamism. Even if Trump could save every one of these jobs, it would still be unwise. That's because for every 100 jobs that are destroyed, another 107 are created. Though painful for anyone who loses a job, this "churn" in the labor market is actually a sign of economic strength, not weakness. It demonstrates the American economy's unparalleled ability to reallocate labor and capital to its most effective use. Economists now believe that productivity, and high and rising living standards are driven by this dynamism.

3. Subsidies encourage bad business decisions. With enough subsidies, Mr. Trump could get firms to grow pineapples in Indiana. But they should leave that to Hawaii. The widely accepted economic theory of comparative advantage tells us that regions prosper when they specialize in producing what they can make at the lowest opportunity cost. If Carrier would not have located those jobs in Indiana but for the subsidy, then Carrier should not locate those jobs in Indiana.

The market was signaling that those activities can be better performed elsewhere. Policy makers can override these market signals for a time, but they can't do it forever. Eventually, economic reality will force the jobs to move, and by then, it will be more painful than necessary because the government will have encouraged market participants to ignore reality.

4. Public "investors" make blind investments. Normally, when businesses make decisions, they are guided by prices, profit, and loss. They pay close attention to these signals because their own skin is in the game. And as F.A. Hayek taught us, these market signals aggregate an incomprehensible amount of knowledge spread out among countless workers, businesspeople, and consumers, giving private investors the best information available. When Governor Pence decides to invest taxpayer resources in Carrier, however, he has no skin in the game, and he is unguided by any market signal that might alert him to the best uses for that money. He is essentially investing blind.

5. Favoritism is the handmaiden to corruption. When government officials selectively favor some firms and not others, businesses are encouraged to seek the favor of these officials. At worst, these sorts of schemes invite gross corruption. At best, they invite a ruinously wasteful phenomenon known as rent-seeking, in which businesses choose to chase favors rather than please consumers.

There are plenty of wasteful but legal means for a firm to ingratiate itself to a politician handing out favors. It can lobby for favors. It can donate to selective PACs. And, importantly, it can undertake bad business decisions in order to attract the favor of the policy maker. Rent-seeking is socially wasteful because it encourages firms to spend scarce resources seeking the redistribution of wealth rather than the production of new wealth. It is even possible for businesses, in aggregate, to waste more money seeking a privilege than the privilege is even worth.

6. Protected businesses are wasteful businesses. Market competition-and even the threat of market competition-keeps firms attentive to costs and to the desires of consumers. But firms that are protected from competition can blithely ignore these factors. That is why the least competitive firms (e.g., local cable monopolies) are often some of the least efficient and the least attentive to customers.

7. Shekels come with shackles. Government favors are rarely free. Policy makers almost always want something in return, and the promises they extract (to invest in a certain factory, to make a certain product, or to market it to a certain community at a certain price) can be extremely costly for the firm over the long run. This means that privileged firms often end up regretting the favors they've won.

8. Privileges undermine the legitimacy of government. John Adams asserted that ours was a government of laws and not of men. And a hallmark of the American tradition of the rule of law is equal protection under the law and a commitment to non-discriminatory policy. With each special interest privilege, we chip away at this tradition and undermine the legitimacy of American government.

9. Privileges conflate real capitalism with cronyism. The rise of populism on both the left and the right comes on the heels of unprecedented bailouts under Presidents Bush and Obama. An entire generation has now come of age in an era in which firms succeed on the basis of government favor rather than merit. No wonder so many deeply distrust this modern, mutant form of capitalism.

10. Privileges diminish economic freedom: When a particular firm such as Carrier is spared the burden of an onerous tax, it has no need to oppose that tax. In fact, since its competitors still labor under the burden, the tax becomes an advantage, and the company may even advocate for its increase. Privileges such as these therefore tend to undermine the most reliable source of genuine economic prosperity: economic freedom.

America was made great by its commitment to the rule of law, to equal protection under that law, and to an open and level economic playing field. It would be great if someone remembered that.