Fixing Economic Development tax Incentives
The corrosive effects of bad development policy.
As Niskanen Center senior fellow Nathan M. Jensen and Edmund J. Malesky note in their book, Incentives to Pander,
Policies targeting individual companies for economic development incentives, such as tax holidays and abatements, are generally seen as inefficient, economically costly, and distortionary. Despite this evidence, politicians still choose to use these policies to claim credit for attracting investment. Thus, while fiscal incentives are economically inefficient, they pose an effective pandering strategy for politicians.
The national competition for Amazon’s HQ2 provides a clear case in point, but is just the tip of the iceberg. Estimates of total state and local expenditures on such subsidies range from $45 to $90 billion a year. The state border running through Kansas City, dividing Missouri and Kansas, is perhaps the clearest example of how such incentives create wasteful tax competition. According to Jensen and Malesky, from 2010 to 2012,
no less than sixty-seven companies in the Kansas City border war received a total of $312 million dollars in tax reductions and other targeted inducements, such as land clearance or infrastructure outlays, to either remain on, or relocate to, one side of the state line.
While rent-seeking behavior is a human universal, corporate welfare of this sort is relatively unique to the United States, both in degree and kind. Despite the many virtues of America’s federalist system of government, states and local officials are locked in a race-to-the-bottom dynamic, motivated in part by the incentives of political leaders to appear proactive.
There is no silver bullet for solving the firm-specific tax incentive rat race. However, stronger disclosure and transparency rules provide an important place to start. When citizens understand the trade-offs involved with development incentives, they are better equipped to judge whether the benefits are worth the costs.
The Niskanen Center’s Struggling Regions Initiative is about improving economic development policy, including identifying the bad and outright ugly elements of the status quo. Keep an eye on this page for featured research and analysis on firm-specific tax incentives and ideas for reform.