Tesla Learns the Hard Way About Crony Capitalism's Downside

Policy makers like to play favorites with private companies, privileging a few with tax breaks and others with subsidies, coming to the rescue of some or surrounding others with regulatory rules to box out the competition. For companies lucky enough to receive these favors, life is good (at least for a while). But life isn't so good for others. Behind every privilege to a particular firm, there is a taxpayer, a customer, or a competitor who ends up paying for it. And those who are privileged today can easily find themselves on the other side of the equation tomorrow.

Tesla Motor Company is coming to learn this lesson the hard way. This past week New Jersey sided with the state's powerful car dealership lobby to keep the electric car manufacturer from selling directly to consumers.

Tesla isn't used to losing political battles. A few years ago, it was the quintessential privileged firm. In 2010 the company launched its initial public offering, raising some $226 million. That same year, Tesla received a $465 million loan from the Department of Energy and began reaping the benefits from a $7,500 federal income tax creditoffered to each of its customers.

Tesla also receives privileges from various states. Its California customers get a $2,500 tax credit for each Tesla they buy. Similarly, customers in Illinois get a $4,000 rebate; Coloradans get a $6,000 credit; and West Virginians get a $7,500 credit. Each of these tax breaks allow Tesla to sell more vehicles and charge higher prices.

But perhaps Tesla's greatest privilege is California's zero-emission vehicle program. It requires that a certain percentage of each automaker's California sales come from zero-emission vehicles and awards automakers transferable credits for each zero-emission vehicle sold. If automakers can't meet their target percentage-and most can't-they must buy zero emission credits from another car maker with a surplus of credits. In 2012, Teslamade over $40 million selling these credits to its rivals. And with the zero emission requirement set to jump from 1 percent of vehicles sold in the state during 2014 to 16 percent in 2016, Tesla is likely to make much more money from credit sales in coming years.

With each of these privileges, Tesla comes out on top. But each entails costs borne by others. Taxpayers are stuck with higher tax bills and/or fewer services because of Tesla's tax loopholes. Other borrowers lose out on capital because banks prefer to make government-backed loans to Tesla rather than un-backed loans to un-favored entrepreneurs. And, of course, competitors lose cash and market share because they don't obtain the same tax benefits as Tesla and because they don't benefit from California's zero-emissions program.

There are other, less-obvious costs, too. Tesla and its competitors sink millions of resources into lawyers and lobbyists whose job it is to convince governments to privilege-or not to privilege-Tesla. Society loses because smart, hard-working people are busy thinking of new ways to create value for politicians instead of creating value for consumers.

Being a privileged firm, Tesla typically doesn't encounter such costs. Instead, it usually encounters the benefits of government favoritism. But this week in New Jersey the company came face-to-face with the very real and socially destructive costs of government favoritism.

And that's because, for once, Tesla wasn't the privileged firm. Instead, New Jersey sided with the state's own local car dealerships. These dealerships have long-benefited from New Jersey's "franchise law," which makes it illegal for car manufacturers to sell directly to consumers. (Imagine what would happen if computer retailers were able to obtain laws preventing Apple from operating its own stores.) All 50 states have such laws, which are-needless to say-popular among car dealers. But economists estimate that these laws raise prices for consumers by about 6 percent.

So far, Tesla was able to make do with the law by operating "showrooms" where the company demonstrates the features of their vehicle for potential customers who may then buy the car online. New Jersey's Motor Vehicle Commission now deems even these showrooms illegal.

For its part, the company accused the state of implementing "the state's laws at the behest of a special interest group looking to protect its monopoly at the expense of New Jersey consumers." The company called this "an affront to the very concept of a free market."

Indeed. Any time governments favor one firm over another, it's an affront to the very concept of a free market. With hope policymakers will remember this point the next time Tesla-or any other company for that matter-seeks a loan guarantee, a targeted tax break, or a regulatory privilege.