Picking winners is for losers

By John Hood

Raleigh, NC – When it comes to giving out business incentives, you won’t find North Carolina at the top of the list. Don’t worry — that’s actually good news.

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Incentives can be targeted tax breaks, loans, marketing subsidies, or direct grants. Politicians use them to try to get companies either to relocate or expand within their jurisdictions. Businesses accept them, naturally, and in a few cases incentives may even be decisive.

But, generally, economic incentives are a failed policy, based on the fundamentally flawed premise that politicians are capable of predicting which companies or industries are worth investing in.

Although it may get me thrown out of the cynical-columnist club to say this, politicians aren’t fools. Incentives don’t fail because most lawmakers or bureaucrats are dumb, or suckers, or corrupt. It’s just impossible for central planners to possess enough information, in real time, to make sensible investment decisions with taxpayer money.

Are they spending taxpayer money, though? Some defenders of incentives argue that allowing select companies to keep their own money, through selective tax breaks or rebates, is not really a subsidy.

I understand why some think that, but basic principles of public finance tell us otherwise. Taxing the income, sales, or property of a business is a means of paying for government services associated with that business activity. It pays for police, courts, and other means of protecting property and adjudicating disputes. It pays to train current workers and educate future ones. It helps to pay for local streets and other infrastructure.

If a company builds or expands in a jurisdiction and then, because of incentives, doesn’t produce as much net revenue as it otherwise would, the expenditures don’t go away. The owners, employees, vendors, and consumers of that company still consume public services. Incentives have the effect of compelling others to pick up the tab.

So far, my argument has been all theory. I don’t mind admitting that — because if we focus instead on empirical data, on actual experience, the theoretical case against incentives gets stronger, not weaker.

Scholars have been researching these policies for decades. Most of their studies find that states and localities don’t improve their economic outcomes by using incentives. They don’t boost average incomes. They don’t boost job creation. Some people gain. Others lose. In many cases, the losers outweigh the winners.

Here are a couple of examples. In a recent study published in the Journal of Economic Perspectives, Cailin Slattery of Columbia University and Owen Zidar of Princeton University found that while an incentive grant may tip the location decisions of individual companies, “we do not find strong evidence that firm-specific tax incentives increase broader economic growth at the state and local level.” They also found that places where incentives attract new firms tend to see decreases, not increases in home prices, suggesting that “the welfare effects of these subsidies might be negative on average.”

Another recent study, published in Economic Development Quarterly, zeroed in on the question of new firms, which are responsible for a disproportionate share of net job growth. The authors found a negative relationship between incentive programs and business startups. “The findings support critics who contend that incentives crowd out other economic activity, potentially reducing long-term growth,” they concluded.

I wish the entire targeted-incentives game would disappear. But I’m enough of a realist to recognize that’s not going to happen. One of Slattery and Zidar’s findings, in fact, is that incentive grants tend to spike just as incumbent governors are running for reelection. Good luck convincing politicians not to wield a tool that, in the end, is more about creating job announcements than creating jobs.

But I do think North Carolina leaders deserve credit for their comparatively restrained approach. States with lower overall tax rates tend to make less use of targeted incentives. Those states also happen to grow faster than the desperate high-tax states throwing huge incentive grants around.

That’s also a common finding in recent social-science research — and I’m a big fan of science, after all.

John Hood is chairman of the John Locke Foundation and author of the forthcoming novel Mountain Folk, a historical fantasy set during the American Revolution.