Congress could use bailouts to solve the interstate subsidy war

Congress has reconvened, and the major topic of debate is the next round of coronavirus relief. One of the most contentious issues at hand is whether or not to bail out state and local governments struggling with a budget gap caused by the pandemic — an idea that, even if necessary, would set a dangerous precedent for governments already prone to flirting with financial ruin. 

Congress does have another option: Ban the massively wasteful economic development subsidy wars that states and localities wage with one another.

Governors and local leaders have asked for $1 trillion in federal grants to respond to a combined $975 billion budget gap projection from fiscal year 2020 through fiscal year 2022. However, Congress could help free up $95 billion in state and local annual spending by banning state and local economic development subsidies. A back-of-the-envelope estimate suggests that the savings over the next two fiscal years would account for almost 20 percent of the projected budget gap (though in practice the full savings would only be realized after states fulfill their existing subsidy contract commitments).

If probably sounds odd to suggest an end to economic development programs at a time when economic growth is desperately needed. But most academic research finds that subsidies have a negligible or even negative economic effect. Subsidized growth at government-favored companies comes with a price tag of higher taxes for other companies and workers and reduced spending on important public services. 

On a broader scale, America’s massive misspending on local economic development subsidies harms national economic growth and our nation’s competitiveness in the global economy. Subsidies encourage companies to pursue profits through politics, rather than innovating better products and services to attract customers.

So why do state and local policymakers continue to offer bigger and bigger subsidies?

First, the economic costs (higher taxes, fewer services and reduced innovation) are hard to measure and occur over the long run, so they’re generally not given enough consideration. Second, taxpayers face greater difficulty in organizing to oppose the subsidies than corporations do to campaign for them. And perhaps most importantly, it’s politically advantageous to take credit for “creating jobs” with subsidies. Ironically, academic research has estimated that on average only one out of every eight economic development deals is completed because of the subsidy — the other seven would have happened without the handout.

Even policymakers who want to end this race to the bottom find it difficult to unilaterally withdraw from the competition. New Jersey Gov. Phil Murphy, who has made a name for himself by opposing the breathtaking waste of subsidies offered under previous gubernatorial administrations, said “I will not unilaterally disarm our economic development while our competitor states are luring businesses, in part, through incentives.”

In a recent study, we argue that the federal government should use its constitutional authority to prohibit the state and local economic development programs that interfere with interstate commerce. 

Congress has a vested interest in doing so; it provided $750 billion in federal grants to state and local governments in fiscal year 2019 alone. Because these grants are partially fungible, and because the “flypaper effect” motivates state and local governments to use the extra funds to expand their spending, federal taxpayers are already funding every competitor in this subsidy arms race. 

This is not a question of the federal government punishing states for their fiscal policies. In fact, officials involved in some of the biggest subsidy competitions would welcome the assistance. Former Kansas City Mayor Mark Funkhouser, whose border city had a front-row seat to the most wasteful subsidy competition in the country, has called for “a national law that prohibits corporations from extracting bribes from state and local governments and bans governments from donating tax dollars to private entities.” 

Congress could end this arms race with one fell swoop. Otherwise the subsidy war will continue to waste trillions of dollars and slow national economic growth, just when we need it most. 

The interstate competition that Amazon provoked for its HQ2 was the “Bridge to Nowhere” moment for economic development subsidies — the way it egregiously and openly played states and cities against each other woke everyone up to the size of the subsidy problem. It took Congress seven years after the Bridge to Nowhere fiasco to provisionally end earmarks, and they still linger nearly a decade later. This time Congress shouldn’t delay, but seize this opportunity to solve the subsidy war between the states.

Michael Farren is a research fellow with the Mercatus Center at George Mason University. John Mozena is the president of the Center for Economic Accountability.