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Wednesday, January 6, 2010

About Those Tax Breaks

Few things bug free-market economists as much as the attempts by local and state authorities to give tax breaks to certain firms in the name of “creating jobs.” This is not because we think that taxes are good or even believe that we need to have equality in spreading the misery, but rather because we hold that such actions ultimately create their own sets of problems. Furthermore, there is something about “corporate welfare” that just gets under our skin.

In the past few decades we have seen big-box retailers and other firms not only receive huge tax breaks, but also work hand-in-glove with states and municipalities to take private property through eminent domain. For example, the infamous Kelo decision came about when the city of New London, Connecticut, seized homeowners’ property for a huge private development that included a politically connected drug company.

However, now that the Great Recession has cut into tax revenues (and since, unlike the federal government, states and municipalities cannot print money), local politicians are changing their attitudes. Companies that have not “created” as many jobs as predicted are finding new tax bills in the mail.

For example, Target promised officials in DeKalb, Illinois, that a new distribution center would create 500 jobs, and in return for locating there, it received a number of tax breaks. Unfortunately for the company, it fell 66 jobs short, and now has been dunned to pay an extra $600,000 in local taxes.

Called “clawbacks,” the rethinking of tax breaks when companies don’t fulfill their ends of agreements is likely to have a big effect on this entire tax-break practice, and I believe the debate should be welcomed. Now, I am not against reductions in taxes, and I absolutely disagree with economists like Paul Krugman who claim that the cut in marginal income tax rates somehow played a major role in creating this recession.

Nonetheless, I believe that these “public-private partnerships” need to be cut back or done away with altogether. From what I have seen, they encourage malinvestments and reward political entrepreneurship rather than real entrepreneurship.

My opinion in part comes from personal experience, as 25 years ago I worked as an “economist” in the federally funded Economic and Community Development Department for the city of Chattanooga. Our office had two main functions. The first was to apply for and administer Urban Development Action Grants (UDAG); the second was to administer community development funds.

The UDAGS were a farce, an absolute joke. Most of the projects ultimately failed or did not perform according to the claims in the applications. Furthermore, the developers themselves were people who did not demonstrate they ever could come up with successful projects that were not government-subsidized.

As for the community development funds, each year we had to deal with the local chapter of ACORN, not to mention everyone else looking for a handout. In the end I see very little good that came out of these programs and a lot of misallocated dollars.

Now, I am not going to say that the presence of a Target warehouse or a Walmart in a community is a bad thing. I happen to like both stores and shop often at our local Walmart. However, tax breaks and eminent domain not only erode private property rights and place government on the side of large, politically connected companies, but they also send the message that private enterprise needs government subsidies to survive.

In fact, these subsidies damage private enterprise. They lead to capital misallocations, encourage political entrepreneurship (that ultimately runs aground on the shoals of economic reality), and create cynicism about the efficacy and fairness of the “free market.”

Yes, companies are struggling right now and many promises of new jobs came in anticipation of a better economy, but there is a larger lesson to be learned here. It is better not to approach politicians with one’s hands out, as they are experts at picking pockets when companies are most vulnerable.

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.