The Siren Call of Tax Abatements

The United States is facing an economic border war. It has nothing to do with NAFTA, but its consequences make Ross Perot's giant sucking sound seem like nothing more that a Dust-Buster. Yet the only skirmish to receive national attention was packaged as a battle about benefits for domestic partners.

Although the media focused on Williamson County's squeamishness About Apple Computer's human resources policy--a juicy story in a country obsessed with health care--the real scoop was that this desolate prairie outpost had promised Apple $750,000 for choosing the county as the site of a new customer service center.

This administrative bribe, or tax abatement, has become the weapon of choice in a destructive economic turf war raging among Balkanized areas across the country.

Tax abatements are not an entirely new phenomenon. Throughout the 1960s and 1970s some states and a few municipalities hit upon the idea that they could encourage local businesses to expand by offering a partial rebate of additional property taxes or user fees that such an expansion might incur.

But these days, in the era of corporate downsizing and structural unemployment, the tax abatements are used rather differently. States and municipalities now actively lure companies away from other locations with huge incentive packages that often cover the company's entire start-up costs and moving expenses. With job creation a political sine qua non, cities and states are forced into ever more costly bidding wars for businesses.

Where the programs of the 1960s and 1970s might be characterized as fertilizing one's economic garden, those of today resemble nothing more than rustling your neighbors' cattle.

Soon to be ex-New Jersey Governor Jim Florio, for example, branded his statewide 234 million dollar tax incentive program his "secret weapon" for economic development This plan led to what both New York and New Jersey officials called a "border war," with each side trying to steal businesses away from the other. The hostilities became so mutually harmful that Florio and New York Governor Mario Cuomo eventually declared a "non-aggression pact."

The dividends companies reap from overeager local politicians are staggering: McDonnell Douglas was offered more than $1 billion in incentives for a planned aircraft plant by several competing cities. In 1991, Minnesota offered Northwest Airlines $840 million in assorted goodies for the privilege of hosting a giant aircraft maintenance center. Ypsilante, Mich. earned the dubious distinction of snagging a GM plant at the cost of $1.5 billion in incentives, only to see GM subsequently shutter the plant and shift production to Arlington, Tex., which offered a fresh round of relocation incentives.

At first blush, incentives look like a reasonably good idea. Government does its part to create an environment conducive to economic growth. Jobs are created, and in theory, both corporate profits and tax rolls grow. Unfortunately, bidding wars have escalated to the degree that government often must beggar itself to get or keep business. Now, for a conservative, this too might not seem like such a undesirable consequence: business succeeds at shrinking government and thus strikes a blow for economic liberty.

Yet the harshest blow is the one struck against efficiency. the huge abatements boost corporate profits, but more significantly they encourage a highly costly and inefficient storm of corporate relocations, and inevitably, social dislocations. Companies don't become more efficient by moving; they merely enrich themselves on the extravagant bribes offered by local governments in order to buy jobs, and hence popularity.

And what about economic liberty? Individuals, and businesses too small to effectively extort these payments subsidize the border-hoppers with higher taxes. Gov. Jim Edgar of Illinois, who is stuck dealing with more than 300 million dollars in incentives doled out to a handful of companies by his predecessor, has come to realize this rub: "Once you get something, you might have given up so much it wasn't worth getting [the project], and everyone else that pays taxes is frustrated," Edgar told the National Journal last April.

In the end, a devastating incentive structure emerges. Investment in infrastructure and education, which would truly make an area competitive in terms of productivity, are slighted in order to finance the artificial lure of tax abatements. And without an educated workforce and a high-quality infrastructure a locality cannot hope to attract businesses; an environment ever more inimical to productivity requires the locality to rely on even more extravagant incentive packages to secure economic development.

Local governments are trapped into a classical Prisoner's Dilemma. If all governments refrained from granting incentives, they would generally gain; but it behooves each local government to entice businesses, which then puts all the other local governments at a competitive disadvantage if they don't jump in the fray.

The problem is exacerbated by the character of local government. Anyone who has dealt with a local zoning board or a state-level bureaucracy knows that such bodies are hardly Institutions (with a capital `I') worthy of respect, so much as institutions (as in "mental') for those with pathologically underdeveloped intellects and overdeveloped egos. How are folks like the cloven-hooved aspiring-deacons of the Williamson County Commission supposed to hold their own against the likes of Apple and its army of Ivy-league lawyer/consultant mercenaries? It's as though Homer Simpson were to take on Gary Kasparov in a chess match. Or to adopt a closer analogy, like the Undergraduate Council attempting to negotiate with concert tour promoters.

Often companies wind up extracting concessions far beyond what would have been necessary to get them to set up shop. Even with their limited cranial capacity, local politicians know the axiom of their craft: namely, that jobs win elections. When County Commissioner Hatfield tires of gloating over stealing a factory from Town Manager McCoy, he'll finally realize that he's hopelessly broken the county's budget for the next ten years. But by that time of course, Conglomerated Industries' consultants are vacationing in Bimini on the bonuses they've earned from this particular boondoggle.

Yet solving this problem is a tricky affair. One option is simply to eliminate regional tax rate discrepancies by eliminating local rights of taxation in favor of broader federal levies. Localities and states would rely, in turn, on federal grants instead of local taxes. Certainly, tax abatement fever would subside, as localities would have little to give away.

Yet local taxation is an important part of American federalism. Communities can decide their own priorities and how much they are willing to pay for them. Further federalizing revenue would also mean centralizing spending decisions in Washington.

On the other hand, a specific ban on abatements would wipe out their pernicious effect, but would also preclude their useful application. For example, a town couldn't help a longtime local company through tough times by easing its tax burden temporarily.

But until local officials somehow get wise to the futility of bidding themselves into poverty to attract businesses, tax abatements are just too damaging overall to justify their possible beneficial employment. Outrageous incentives must go. Taxes are not some form of negotiable tribute: states and localities must adopt fair tax rules and apply them justly to all citizens and businesses. If the participants in this border war can't negotiate a cease-fire, their weapons must be taken away.