November 13, 2018

Amazon HQ2 Is the Only Competition Where the Losers Are Winners

Why Economic Development Subsidies Hurt More than They Help

In September 2017, Amazon sparked a large-scale bidding war among 238 North American cities, each eager to prove why it is the best location for Amazon’s expanded headquarters, HQ2. Based on a limited number of publicly-available bids from the 20 semi-finalists, we calculated the average offer: $2.15 billion from cities and $6.75 billion from states over the next 15 years.

Despite arguments in support of economic development subsidies, both theory and experience suggest that cities and states are throwing their money away when they court Amazon’s favor through subsidies. Even subsidies worth billions of dollars are unlikely to sway Amazon’s decision. Worse, these kinds of targeted economic development incentives fail to produce economic growth.

In this study, we examine the publicly-known subsidies offered to Amazon as enticements to locate its second headquarters. We show that these subsidies are unlikely to alter the location decision of the company, or lead to economic growth for the communities that offer them. We illustrate the tradeoffs that these subsidies would require in terms of forgone tax cuts and alternative uses of these funds for public services, like safety and education. Lastly, we offer examples of institutional reforms—constitutional gift clauses, direct democracy, and interstate compacts—that could reduce the number of corporate subsidies in the future.

Subsidies Typically Don’t Sway Corporate Location Decisions

There are more important factors than tax incentives and direct subsidies, e.g. the presence of a skilled workforce, local cost of living, access to transportation, and synergies with other industries. Over the long term, these factors can lead to far greater growth than a multi-billion dollar offer.

Targeted Economic Development Subsidies Don’t Lead to Economic Growth

The general conclusion of academic research suggests that targeted economic development subsidies don’t lead to broad-based economic growth or improvements in community welfare when measured against comparison cities. Why? First, when government officials grant targeted tax cuts, they distort the market-determined prices that lead to the most efficient use of resources. Second, nearly every kind of tax causes additional price distortions and corresponding “deadweight loss”—a pure loss of economic value. This means that keeping taxes high for some businesses to give a subsidy to favored corporation causes further harm to economic efficiency—a better approach for economic growth would be a broad-based tax cut. Lastly, politicians don’t make good investment decisions with economic development subsidies. Their choice of whom to subsidize isn’t limited by their own budget because they are not investing their own resources, nor do they reap the long-run future payoff for investing wisely.

Moreover, targeted subsidies are most often used to benefit large, highly-visible corporations rather than small local businesses. As a result, struggling local businesses must pay higher taxes to fund public subsidies for politically well-connected larger corporations.

HQ2 Subsidy Proposals Create Tradeoffs in Public Services and Tax Policy

Using the average subsidy at the state level, we estimate how much each state could reduce its corporate income tax over the life of the subsidy. On average, these states could reduce their corporate income taxes by 29 percent for the 15-year duration of the $6.75 billion subsidy. Most strikingly, Colorado, Maryland, and North Carolina could all cut their corporate income taxes by over 70 percent.

Alternatively, we illustrate the tradeoffs of the average subsidy bid by calculating the effect of using that amount to fund public services. Instead of offering the average $2.15 billion subsidy over 15 years, semi-finalist cities could, on average, increase its police force by 56% or educate 8,000 public K-12 students each year.

In addition, the average $6.75 billion state subsidy could pay for, on average, 8 years of statewide roadway maintenance or fund almost 30,000 annual full-tuition scholarships at the state’s flagship university.

Solving the Economic Subsidy War Between the States Is Possible

Though the solution to the problem of economic development is neither simple nor straightforward, we propose institutional reforms that could close off government privilege-granting, including state constitutional reforms, direct democracy solutions, and interstate compacts.

Conclusion

The meteoric rise of Amazon since its initial humble launch as an internet book seller barely 20 years ago illustrates the effectiveness of the company and its leadership. Because of this, we find it implausible that Amazon’s corporate leaders didn’t already have a good idea of where they would locate HQ2 even before launching the competition between cities.  The research on corporate location decisions finds that subsidies rarely affect the final decision, lending weight to our skepticism. It also suggests that any relocation subsidies would simply be extra icing on the cake that Amazon had already picked.