All Commentary
Wednesday, November 1, 1995

A Solution to the Incentives War?

Government Incentives for Businesses Fail to Create Net Benefits for the General Public

Mr. Cline is research fellow at the John Locke Foundation in Raleigh, N.C., and managing editor of Carolina Journal Weekly Report, a newsletter of politics and policy delivered by fax and e-mail.

In 1936, the Mississippi state legislature attempted to minimize the effects of the Great Depression by enacting the “Balance Agriculture With Industry” act, the nation’s first state-sponsored economic development plan.

Fifty-nine years later, each of the 50 states runs its own economic development program, a government-controlled effort to actively recruit business. As was the case with the federal government, the role of the state governments was redefined in the 1930s. No longer were they relegated to providing infrastructure and education. Legislators of the time re-interpreted government’s role from a passive one to an active one.

One of the results has been the creation of 50 different activist state governments, each trying to lure businesses into its boundaries with packages of tax cuts, outright bribes, or both. Even local governments have gotten into the act.

Most medium-sized or large American cities have some sort of economic development program with the intention of attracting businesses. The cities throw out public incentives packages, and the perception is that the city with the most attractive package gets the most attractive company. But incentives don’t always work that way on the state or local level.

In 1993, Illinois gave Sears a $178 million package in exchange for locating an office complex in the state, New York City gave $362 million in incentives packages to numerous companies in just eight months, and Alabama gave Mercedes-Benz more than $300 million to locate its first U.S. manufacturing plant within the state boundaries. Now, just two years later, government leaders are beginning to realize that those cozy deals were not a wise investment of public money. In Alabama, the entire practice of luring companies with incentives is being rethought. But in North Carolina, the threat to such programs has come from two surprising sources: the state constitution and an aware lawyer.

How the Game Works

North Carolina Governor Jim Hunt has spent $12 million in public money to lure 12,000 jobs into the state since his Industrial Recruitment Competitive Fund was created in 1992. That’s about $1,000 per job. And the legislature has given him $2 million more for the next fiscal year.

While the governor is trying to draw businesses away from other states, North Carolina’s cities are trying to draw businesses away from one another and from neighboring states. For the past few years, tiny towns such as Sparta have been joining forces with counties to draw companies from Virginia, South Carolina, and Tennessee. Large cities such as Charlotte and Winston-Salem have been trying to draw the larger corporations that the smaller towns cannot get.

The theory set forth by government officials to justify their spending is this: public incentives attract large companies which hire large numbers of workers, thus creating jobs for large numbers of state residents. Because jobs are created, such incentives are in the public interest, and hence the use of public money is justified. But in practice, these incentives don’t live up to their promise of serving the public.

For example, North Carolina gave Quaker Oats Co. $98,000 to build a new 98-worker plant in Asheville, fulfilling the state’s $1,000-per-job rule. Apparently unnoticed in the transaction was that closing the old plant, also located in North Carolina, would eliminate 70 jobs. So the state paid $98,000 to create only 28 new jobs—a total of $3,500 per job. In other cases, companies have promised the state certain numbers of jobs, but after taking the state money have failed to deliver.

For some companies, subsidized incentives have literally no bearing on location decisions, but they grab for some of the free cash anyway. Hoping for a payoff, a mill told North Carolina officials that the company’s expansion project would be valued at $100,000. But when the company finally moved to Virginia—because North Carolina utility rates were too high—it revealed the value of the expansion was only $80,000. Officials of a furniture company made state economic developers aware of the generous offers they received from other states and hinted that the company would not locate in North Carolina unless the state topped the other offers. The state did not, but the company’s new distribution center sits in North Carolina anyway, in Rocky Mount. There is also academic evidence to support these anecdotes. A 1994 study by two professors at University of North Carolina at Charlotte found that, among North Carolina manufacturers, the first three factors in making location decisions were local public schools, local work attitudes, and labor availability. Government-subsidized incentives ranked 22nd.

Not only are incentive packages somewhat ineffective and open to rife abuses, but they are terribly unjust. A city taxes businesses. It then uses some of that tax money to lure outside companies. Every business in the city thus contributes to its own potential harm by subsidizing its competition. Incentives-crazed politicians don’t seem to realize that businesses compete for more than customers. They compete for a limited pool of qualified employees, land, shopping mall space, and so on.

Government incentives also discriminate against small businesses and recent start-ups by offering money only to companies that can create large numbers of jobs. Small and newly created companies are automatically left out of the running for the funds. How can a mom-and-pop hardware store be said to benefit when part of its tax money subsidizes the relocation next door of an aircraft carrier-sized home improvement megastore that was given $50,000 in state money for bringing 50 jobs into mom and pop’s neighborhood?

Another important issue no one seems to have noticed is this: North Carolina has a serious labor shortage. There simply are not enough qualified workers in the state to fill all of the good jobs. How then is it in the public interest to bring in more unfilled jobs?

Unfortunately, the government rhetoric has been effective; it has convinced many citizens that “more jobs are good, fewer jobs are bad.” Furthermore, most citizens don’t even consider the problems inherent in taxing the eastern Carolina residents of Wilmington to pay for new jobs in Asheville eight hours west by Interstate.

The most effective and just way for government to promote economic development is to maintain a pro-growth business climate by keeping taxes low and treating entrepreneurs as valued rather than despised citizens. Giving tax money to individual companies creates a tilted playing field that benefits large corporations at the expense of smaller entrepreneurs, who create most of America’s jobs.

Stopping the Game

One North Carolinian has seen through the ruse. The issue of locally subsidized competition caught the eye of Winston-Salem lawyer William Maready. He met several times with the leaders of Winston-Salem and Forsyth County in an attempt to understand how taxing local businesses to pay for the relocation of other businesses could be construed as in the public interest. The officials failed to convince him.

Maready filed suit as a Winston-Salem taxpayer. He charged that the city’s and county’s use of economic incentives violated both the equal protection and public purpose clauses of the North Carolina constitution. He argued that “the use of tax money collected from the citizens of this county to subsidize corporations for moving here or expanding here is unconstitutional, illegal, unfair, unwise—and plain bad government.” Superior Court Judge Julius Rousseau agreed and ruled in Maready’s favor. Government “incentives” given to big business to entice them to locate within a political entity’s borders, he said, do not constitute a legitimate public use of taxpayer money. “It’s an arbitrary way of spending public money.” Lawyers for the city and county decried the judge’s decision and indicated the state Supreme Court would vindicate their clients on appeal.

According to North Carolina’s Governor, the decision was “a mistake” and “bad public policy.” But Maready stands on firm ground. To date, not one incentives proponent has been able to demonstrate that government incentives create a net benefit for the general public.