Losing the Prisoner's Dilemma Game: Economic "Development" Incentives are a Total Waste of Money

From today's WSJ:

The race to woo companies has intensified as state and local governments struggle with a slow economic recovery, sluggish new business formation and job losses resulting from automation. Many older industrial cities see tax incentives as one of the few levers they can pull.

The fight to attract and retain companies “is probably as competitive as it has ever been in the 30 years I have been doing this type of work,” said Lawrence Kramer, managing partner with Incentis Group, the consulting firm that helped Riddell with incentive negotiations.

Economic-development tax incentives more than tripled over the past 25 years, offsetting about 30% of the taxes the companies receiving incentives would have otherwise paid in 2015, compared with about 9% offset in 1990, according to an analysis of incentives covering more than 90% of the U.S. economy.

By 2015, the total annual cost of these incentives was $45 billion, according to the analysis, by Timothy Bartik, a senior economist at the W.E. Upjohn Institute for Employment Research in Kalamazoo, Mich. The study looked at 47 cities in 32 states plus the District of Columbia.

Total incentives are likely higher because the analysis didn’t include some used by cities, including Elyria, such as city income tax rebates for companies.

Seriously, how absolutely pointless is this:

When Elyria Mayor Holly Brinda learned that Riddell Inc. was looking to leave this small city in northeast Ohio, she came up with a $14 million package of tax incentives and offered to lease land to the company for $1 a year.

It wasn’t enough. Riddell, which makes the football helmets used by many NFL and college players, decided to move its roughly 320 employees just over 2 miles down the road to a neighboring town, which offered its own bundle of incentives and lower corporate and individual income-tax rates.

You can't even argue you are trying to save jobs for local people, because the same people are working, just with a 2 mile delta in their commute.

One of the very earliest posts on this blog, waaaay back in 2005, was to compare local economic development spending to a prisoner's dilemma game:

politicians who are approached by a company looking for a handout for business relocation face what is called the prisoner's dilemma.  Many of you may know what that is, but for those who don't, here is a quick explanation, via the Stanford Encyclopedia of Philosophy:

Tanya and Cinque have been arrested for robbing the Hibernia Savings Bank and placed in separate isolation cells. Both care much more about their personal freedom than about the welfare of their accomplice. A clever prosecutor makes the following offer to each. "You may choose to confess or remain silent. If you confess and your accomplice remains silent I will drop all charges against you and use your testimony to ensure that your accomplice does serious time. Likewise, if your accomplice confesses while you remain silent, they will go free while you do the time. If you both confess I get two convictions, but I'll see to it that you both get early parole.  If you both remain silent, I'll have to settle for token sentences on firearms possession charges. If you wish to confess, you must leave a note with the jailer before my return tomorrow morning."

The "dilemma" faced by the prisoners here is that, whatever the other does, each is better off confessing than remaining silent. But the outcome obtained when both confess is worse for each than the outcome they would have obtained had both remained silent.

I hope you can see the parallel to subsidizing business relocations (replace prisoner with "governor" and confess with "subsidize").  In a libertarian world where politicians all just say no to subsidizing businesses, then businesses would end up reasonably evenly distributed across the country (due to labor markets, distribution requirements, etc.) and taxpayers would not be paying any subsidies.  However, because politicians fear that their community will lose if they don't play the subsidy game like everyone else (the equivalent of staying silent while your partner is ratting you out in prison) what we end up with is still having businesses reasonably evenly distributed across the country, but with massive subsidies in place.

Of course, garnering positive press releases for politicians' re-election campaigns is part of the equation as well.  Actually, the game is worse than a prisoner's dilemma game because politicians playing it enjoy all the positive benefits while the price is paid by others (taxpayers).

It would be great to ban this stuff entirely.  But you know what, Arizona already did!  In its Constitution no less.  And we still can't stop this BS.  Our Constitution reads that neither the state nor any municipality in it may “give or loan its credit in the aid of, or make any donation or grant, by subsidy or otherwise, to any individual, association, or corporation.”  This seems pretty definitive, but as I wrote here

This has been interpreted by the courts as meaning that if a state or municipal government gives money to a private company, it must get something of value back - ie it pays money to GM and gets a work truck back.  But politicians will be politicians and have stretched this rule in the past out of all meaning, by saying that they are getting "soft" benefits back.  In other words, they could subsidize the rent of a bookstore because reading is important to the community.

The Goldwater Institute in AZ keeps filing suit and has been pretty successful in blocking some of the most egregious subsidies, but it takes constant vigilance, and at the end of the day, if politicians want to throw money at private companies in order to help their re-election chances, they are going to do it.

 

  • slocum

    But isn't this just a form of tax competition? And don't libertarians generally favor tax competition between jurisdictions (as a way to keep rates down), while statists (like those running the EU) are always trying to stamp out tax competition:

    https://mises.org/blog/eu-vs-apple-vs-ireland-why-tax-competition-good-thing

    Obviously, it would be better to have lower tax rates overall rather than granting special rates to large employers. But on the other hand, these tend to be large firms about to make significant capital investments such that, once made, it will be hard for them to exercise 'exit' as an option, so I'm not sure it's unreasonable to get a guaranteed low tax rate in writing ahead of making the investments.

  • Sam P

    This isn't competition to provide a better business climate, it's special favors for a specific person/organization. These are not the same thing.

  • Mercury

    Nonetheless, has it or has it not worked out for Redmond, WA?

    Maybe one size doesn't fit all here...

  • slocum

    No, it's not exactly the same. But it's more for a specific type of business rather than businesses having particular connections (e.g. cronyism). Any large employer about to make a significant capital investment can get a lower tax rate because of competition between jurisdictions. Is that as good as a lower rate for all businesses? Nope. But I'd still argue it's better than nothing.

  • slocum

    And note, too, that part of the reason Riddell moved was for "lower corporate and individual income tax rates". Those are general rates -- not company-specific property tax-abatement deals. Competition over local income tax rates is a good thing, as far as I'm concerned.

  • Peabody

    It isn't for a specific type of business, it is for a specific business.

    And I would disagree with your conclusion that it's better than nothing. It creates an artificial advantage for one particular business over its competitors. You can argue that its competitors should do the same thing, but if you are an upstart football equipment manufacturer with 15 employees, governments are going to cut you a sweetheart deal.

  • DirtyJobsGuy

    Here in CT we are both poor players at the game but also hooked. Watching the GE headquarters leave shocked many. I think the biggest attraction to companies is that a deal like this is not just cash but also stability. In many cases the deal shelters you from shocks that could come as the government scrambles for cash. So you threaten to leave to buy protection from the state. In our case the state and it's largest cities are essentially bankrupt and the favorite paths forward will aim right to squeeze the business goose. Like businessmen in the Arab world you reduce fixed assets and move cash out of the jurisdiction.

  • slocum

    If you're a startup business, there are typically other programs (incubators, small business grants, state VC funds) available. But for established businesses, though the specific tax deals are firm-by-firm, the availability is effectively universal (for example, has a new auto assembly or auto parts plant been built -- or an existing one expanded -- anywhere in the U.S. without tax incentives?)

  • mlhouse

    To me it is sort of like being an established DirectTV/Cable customer and you see them offering deals and pricing to new customers. The long term value of a new customer has a lifetime value that is worth giving incentives away to sign up.

    I think the main problem with government offering these subsidies to retain or attract business isn't necessarily the subsidy itself which can be seen as a real investment with a positive return, but rather that the government is so bad at measuring the returns and understanding the investment, and this goes beyond these deals. So they "invest" in sports stadiums, rail infrastructure, retail, and many other ideas that never pay off.

  • CC

    There is so much of this abuse. It is the result of such high tax rates. High corporate taxes are not only a drag on job creation, but cause businesses to devote lots of unnecessary resources to accounting and to tax avoidance activities. When the IRS says you have to keep track of and depreciate all capital expenses, an accounting bonanza is born but this is not productive work, it is busy work. A corp would not do all of that just to demonstrate how it is doing for shareholders and the markets.
    One help would be to allow immediate costing of all expenses.
    Another would be to eliminate all corp taxes (oh, I know, they have to pay their share). A higher personal tax rate would have to make up the difference. Please no VAT--that is just a way to hide the taxes.

  • rst1317

    Minneapolis has the same different problem with sports stadiums. The people are tired of seeing people starve and freeze while an entertainment business gets 1/2 a billion in public $. The politicians ignore it when it suits them.

    http://www.startribune.com/stadium-bill-skirts-vote-on-tax/119226314/

    Authors of a bill to use public subsidies for a new Minnesota Vikings stadium say their legislation will allow a local government to increase sales taxes for the project without taking it to the voters first.

    By receiving an exemption from state law, the Vikings stadium plan would follow the same road map that proved successful -- though controversial -- in 2006 for the Minnesota Twins' Target Field.

    Five years ago, in a move that may have been the difference between success and failure, the Legislature allowed Hennepin County to levy the countywide sales tax that now pays for much of Target Field without a voter referendum.

  • rst1317

    The problem is that they're not competing to raise revenues but taking local tax $ and giving them to a company. Big, big difference.

  • obloodyhell

    }}} at the end of the day, if politicians want to throw money at private companies in order to help their re-election chances, they are going to do it.

    The solution is obvious: Don't let them have money to spend.