Stadiums, Subsidies, and other Wishful Thinking (Part 2)

As promised, the outrage continues this week with an exploration of wishful thinking economic development policies. Part one of the series is available here.

While there’s some evidence that local government is getting a bit more savvy (or at least is under more scrutiny) on flashy white elephant investments, I’m not sure the same consensus has developed in a similar arena: public subsidies and tax benefits for companies to relocate.

It’s time to seriously pare back our addiction to this type of spending. There are as many cases as there are states of companies being lured in by the use of public money only to fail, leave again, or extract even greater public resources. I’ve previously written about how Texas could lead the way in cooling the economic development arms race (spoiler alert: they haven’t) and referenced before how badly Reno got fleeced by Tesla.

Just one extreme example that hits close to home in New England is Curt Schilling’s 38 Studios. Before he was famous for politically incorrect tweets, I’m told that Curt Schilling played baseball. After his retirement, Schilling started a video game company in Massachusetts with the modest goal of dethroning World of Warcraft, the highest grossing video game of all time. Ambitious, sure, but companies thrive on ambition.

Schilling convinced Rhode Island  that subsidizing his company would turn around the struggling state, then at the height of its unemployment and economic problems. This sort of deal, where one state pays for jobs or offers a low interest loan to a company to relocate over a state border, is absurdly common in the US. I don’t need to tell you where this goes, right? Rhode Island gave 38 Studios a $75 million loan guarantee, and in 2012 the company declared bankruptcy. Litigation has dragged on to determine how much RI is on the hook for.

The New York Times did an excellent post-mortem that will take you through all the steps, but this sums it up well:

If there’s a lesson in all this, it probably has to do with the limits of what any government can — or should — do to bring about growth. Just about every state offers some kind of tax incentive or loan program for businesses looking to relocate. But Rhode Island went further than that; in its zeal to land Mr. Schilling, the state took on the role of venture capitalist, without having the expertise to do it well.

An actual venture capital firm would have been investing in many companies at once, to minimize its exposure, and it would have demanded a sizable equity stake. It would have taken a seat on the board so it could monitor the money closely and, if needed, restructure the company. Rhode Island, instead, threw most of its venture money into a single, highly speculative start-up, insisted that it more than double the size of its work force, and then walked away.

I tend to agree that government cannot and should not be responsible for making investments in individual companies. Even when they have the best of intentions, they don’t have the experience, capacity, or distanced judgment to make wise investment decisions.

While the article makes the point that the state acted inappropriately and ineptly as a venture capitalist, to me the affair brings into question the entire structure: where is the proof that paying firms in the name of providing jobs is a good idea?

One Man’s Investment is Another’s Corporate Subsidy

The 38 Studios story gets more play than others like it because of the personalities involved, but if you get too caught up in the narrative, you’ll miss the larger point.

First, it’s not very useful or interesting to talk about good intentions. I’m sure Curt Schilling thought his company would succeed – he’s also lost tens of millions in the project. When we talk about the use and abuse of the subsidy system, the reasons vary. Some have noble goals, some are greedy, some are just making decisions that are advantageous within the economic system.

Second, it’s not a partisan or regional issue. Republicans and democrats both support a wide range of corporate subsidies. No state that I know of is appreciably leading the pack when it comes to moving away from ineffective corporate subsidies. There’s just too huge a disadvantage to being first.

Instead, what you should take away from the story is that far more likely than a 38 Studios is the everyday transfer of wealth from citizens to businesses. Have a look at Rhode Island’s page on Good Jobs First’s Subsidy Tracker:

RI Good Jobs First Subsidy TrackerThere’s 38 Studios, third on the list, but it is easily outranked by the 30 subsidies given to home state hero CVS Health (from Woonsocket, RI). I’ve talked about the subsidy tracker before, but you should really look at it in your own state.

In the vast majority of cases, when a state or local government provides tax incentives for jobs, they are not creating new economic activity but instead simply relocating it from a different place. Because of measurement issues, it’s also unclear that the incentives themselves are what induces the economic activity at all. It could be that they just sweeten a decision that is already going to be made, squeezing local finances for no local gain. After all, as critics of these schemes point out, the jobs are going to exist somewhere if no one subsidizes them.

Proponents of tax incentives will also point to equity as an advantage. Maybe, even with the above shortcomings, it still makes sense to use the lever taxes to bring jobs to places they might otherwise not go – high poverty or unemployment areas that desperately need to build an economic base. The problem is that tax incentives are rarely used in the areas that fit the profile of a market failure. Even in the rare cases that incentives are used to bring jobs to high-need places, the local governments can ill afford to subsidize the companies, especially if wealthier areas in the hunt bid up the price to attract a business.

A Zero Sum Game

Academics and top level policy makers understand that economic growth actually depends on regional cooperation, but word hasn’t reached everyone. Indiana and Illinois to this day go back and forth on a recruitment border war, boasting about how they will “rip the economic guts” out of each other. This is obviously a point of pride for the politicians, but sounds to me like someone bragging about how much they paid for their used car.

There’s no question government has an important role to play in the economic landscape. The things I’ve outlined above are not criticisms of the federal government investing in basic research, or local and state governments incentivizing the development of new businesses, or even helping existing businesses get to scale. State governments should have a role in investment in workforce and infrastructure, especially in regions with fewer resources, as a means to make them attractive to business. Local governments should work closely to provide services businesses and workers need, which inevitably means the expense of resources.

What we really need is a coalition at the federal level that can help the states help themselves out of addiction to corporate subsidies. Don’t hold your breath for this to happen in Washington. In the meantime, think about what your state could do to get itself out of this dangerous game.

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Texas Should Unilaterally Disarm

When it comes to spending public money to woo companies, there’s other states and then there’s Texas. The Texas Enterprise Fund, created at the behest of Texas Governor Rick Perry a decade ago, was funded to the tune of $285 million from the rainy day fund. During Perry’s tenure the Fund has given over $500 million in deal “sweeteners” to convince companies to move or expand operations in Texas. The Fund is under the Governor’s control, requiring the signoff only of the Texas Speaker of the House and Lieutenant Governor (which are – surprise – members of the same party in Texas).

The Fund supposedly helps Texas secure “close deals” by providing low cost loans to companies that otherwise would almost but not quite consider Texas. Already we can see the absurd logic – public officials pretend they have perfect insight into businesses’ decision making, and know just the right amount (and no more) to sway the companies’ interest. Defenders argue that the Fund helps bring jobs and creates a return on investment for taxpayers for doing so.

In fact, the Fund went unaudited for ten years. Rick Perry repeatedly accepted campaign donations from executives of companies that received subsidies. Now, even Perry’s Republican successor, Greg Abbott, is questioning whether the fund will continue under his leadership (we’ll see: it’s easy to criticize Perry for “picking winners and losers,” more difficult to give up the privilege oneself).

Texas could take a huge step to deescalating the Economic Development dollars arms race by discontinuing the TEF. Texas is probably the only state that could have a major effect by unilaterally disarming.

Let’s take a step back. Almost every state has a shadowy, poorly understood network of public dollars that are used to woo companies – whether with outright cash grants, energy price deals, tax abatements, or any number of other fuzzy and opaque methods.

Texas under Perry has elevated this style of business to an art form. Beyond ensuring that his state has low energy prices and regulations – fair game for a Governor – Perry has also famously gone on whistle-stop tours of California and New York, encouraging businesses to relocate to the promised land of Texas.

Some interested parties theorize that it is the Texas Enterprise Fund that really fuels the “Texas Miracle” of recent high job growth. Eliminating it, they say, would hurt the Governor’s ability to hustle for Texas like the auctioneer at a county fair.

There’s a lot of problems with this line of thinking. First, without a public audit, there’s little evidence to suggest taxpayer dollars are helpful, let alone decisive, in convincing the companies to expand in Texas. Second, the combination slush fund/glad-handing business development method is based on an outmoded, beggar-thy-neighbor view of economic growth.

For decades, economic development professionals learned how to lure companies over state lines with bigger and bigger offers of public dollars. It’s this dynamic that created a proliferating arms race of economic development spending at the state, regional and local level. Although under more scrutiny in recent years, the trend reached an absurd crescendo in Reno’s wooing of the Tesla “Gigafactory” to Nevada. I strongly encourage you to read this Fortune piece on the bizarre dance of a company savvy at exploiting $1.5 billion in public funds.

Slowly, people are starting to realize that this development strategy is an overall loser for taxpayers, the country and even the states themselves. Spending a declining amount of public investment dollars on wooing footloose companies can be an unwise investment undermining regional growth and cooperation, which is seen as a more important engine of success than gains and losses over state borders. If you zoom out to the US perspective, moving a company from California to Texas at significant public expense is obviously a net loss.

Texas can afford to ignore some of these trends. It’s doing well economically, propelled by gas and oil, healthcare and technology. The rainy day fund is so flush Texans are spending it on road repairs. Its cities are largely within, rather than straddling, state borders. It already has an attractive argument for multinational corporations: base your business here and you’ll have cheap labor and a government that doesn’t get in the way.

These same factors make it possible for Texas to lead the way on the path away from the arms race. First of all, a curious left-right coalition is emerging against the “crony capitalism” or “picking winners and losers” (depending on your political party) of the Perry Governorship. Texas is doing well now and can afford to take the hit – if there actually is one – of not paying companies to relocate there. If Greg Abbott and the Texas Legislature can work together to loudly rebuke the model, it may just provide a precedent that could spill over to other states.

It is certainly true that other states might redouble their efforts to fill the Texas-sized hole, but other states don’t have the cash or appeal of Texas. Texas politicians can seize this moment of left-right disenchantment with corporate subsidies to their own political advantage, which might make politicians from other states reluctant to double down on the old strategy. Playing on the selfish desires of Texas politicians has never gone wrong, has it?

Texas Subsidies
Top 10 Recipients of Subsidies in Texas.  
Source: Good Jobs First Subsidy Tracker

Another concern – that Texas will continue to use other, more shadowy funds in TEF’s absence – is almost certain. The Good Jobs First Subsidy Tracker shows that many companies received hundreds of millions in public dollars from outside the TEF. A Berkshire Hathaway subsidiary, for example, received a staggering $800 million in Tax Increment Financing benefits, independent of the TEF.

While not a comprehensive solution, eliminating the Texas Enterprise Fund is still a good first step to refocusing the conversation. It is the most transparently politically connected fund with some chance of affecting the national trend. Call a truce, Texas.