Half Past the Month: That Crony Capitalist Elephant

May 11, 2018

AN ELEPHANT HAS ENTERED THE ROOM of Indiana’s economic-development officialdom. Nobody wants to talk about the growing amount of research challenging its policy formula. It costs a lot and it doesn’t seem to work.

An adjunct scholar of the Indiana Policy Review last month described it in the inverse. He told a group of Indiana businessmen and opinion leaders they would be better off without any official economic-development effort whatsoever. Rather than provide an economic advantage over competing cities, he says it has merely facilitated a “race to the bottom.” (1)

And today, a city councilman cited the previously ignored research to support defunding his community’s economic-development apparatus. (2) Specifically, he would repeal his city’s business personal property tax, the one that local economic-development agencies exempt in order to favor certain businesses over others. He noted that Indiana’s total effective tax rate on mature capital-intensive manufacturers is 19.2 percent compared with 5.1 percent in Ohio and Michigan. Reducing or eliminating that disadvantage across the board would help attract jobs and investment, some say, as well as stymie crony capitalism. 

Yet, states and localities are spending approximately $70 billion per year on targeted incentives. Property tax abatements, tax increment financing and job-creation tax credits for “new or expanding businesses” have more than tripled since 1990. And Indiana has dived full in. Gov. Eric Holcomb and the mayors of Indiana’s mid-sized and larger cities are enthusiastic participants in the new policy formula as was Vice President Mike Pence when he was in the governor’s chair. Meanwhile, Indiana media is reticent on the issue — fearful maybe — and not asking the hard questions about how it all is working out.

So who’s right? Economists at George Mason University (3) have assembled a review of the literature on the subject. Read the citations and decide for yourself:

• First of all, targeted incentives fly in the face of modern economic theory that shape human activities and economic outcomes toward what Adam Smith called “a system of natural liberty” channeling private self-interest toward the public good. — North, Douglass. (1990) Institutions, Institutional Change and Economic Performance. Cambridge University Press: Cambridge, UK.
• While targeted tax cuts and subsidies might spur economic activity among privileged firms, they discourage economic activity elsewhere in a city’s economy by necessitating higher tax rates for firms and customers in non-privileged sectors. — Rosen, Harvey and Ted Gayer. (2013) Public Finance. 10th Edition, McGraw-Hill Education: New York, New York.
• When targeted incentives entail outright subsidies, they encourage investments in which marginal costs exceed marginal benefits, resulting in too much of the subsidized activity. — Mitchell, Matthew, Jeremy Horpedahl, and Olivia Gonzalez. (forthcoming). “Do Targeted Economic Development Incentives Work as Advertised?” Mercatus Working Paper.
• Subsidies insulate privileged firms from competition, making them less efficient and less accountable to consumer demands. — Leibenstein, Harvey. (1966) “Allocative Efficiency vs. ‘X-Efficiency,'” American Economic Review, 56, 392–415.
• The very possibility of selective privileges encourages firms to inefficiently spend resources seeking privilege from policymakers. — Tullock, Gordon. (1967) “The Welfare Costs of Tariffs, Monopolies, and Theft,” Western Economic Journal, 5, 224–232; Krueger, Anne. (1974) “The Political Economy of the Rent-Seeking Society,” American Economic Review, 64, 291–303.
• Targeted policies reward small, highly organized interest groups with concentrated benefits paid for by taxpayers, consumers and other competitors. Relative to the beneficiaries, the groups that pay for these targeted benefits are unorganized and diffuse and so tend to find it costlier to resist these policies, even if the total costs exceed the total benefits. — Olson, Mancur. (1965) The Logic of Collective Action: Public Goods and the Theory of Groups, Second Printing with New Preface and Appendix. Revised. Harvard University Press: Cambridge, Massachusetts.
• An extensive review of 90 peer-reviewed studies that empirically assess the effect of targeted economic development incentives on a variety of economic variables distinguished between those studies that take a narrow-scope approach, or “assess the effect of incentives on the favored firm or region,” and those that take a broad-scope approach, or “assess the effect of incentives on the community at-large.” This distinction is important because the stated aim of targeted incentives is to promote economic development for the entire community that funds the project, not just for the targeted firm or region. Of 32 studies that examine the effects of targeted incentives broadly, only 3 (9 percent) find positive effects while 6 (18 percent) find negative effects for the community at-large. The rest either find no statistically significant effect or mixed results.5 Among the 58 studies that take a narrow approach to assessing targeted incentives, 38 (66 percent) find privileged firms and regions benefit from targeted incentives while the rest find insignificant, mixed, or even negative results. — Op. cit., Mitchell, Horpedahl and Gonzalez.
• Targeted incentives, since they are not economy-wide, might encourage policymakers to “increase spending and raise tax rates to recoup exempted tax revenue.” It is unclear whether targeted incentives are “a form of government-constraining competition or an example of unhealthy crony capitalism.” — Dove, John and Daniel Sutter. (2018) “Is There a Tradeoff between Economic Development Incentives and Economic Freedom? Evidence from the US States?,” Mercatus Working Paper, Mercatus Center at George Mason University, Arlington, VA.
• A look at Tax Increment Financing (TIF) in Missouri, assessing whether the number of jobs reported by TIF proponents correlates with Bureau of Labor Statistics (BLS) data on actual employment finds no relationship between the jobs numbers reported by economic developers and BLS local employment data. Furthermore, it finds that when TIF is used to retain jobs, the number of reported retained jobs is negatively related to municipal employment, suggesting jobs retained as part of the TIF came at the expense of jobs elsewhere in the community. — Byrne, Paul. (2018) “Economic Development Incentives, Reported Job Creation, and Local Employment,” Mercatus Working Paper, Mercatus Center at George Mason University, Arlington, VA.
• A look at data across states to see if economic incentives seem to be used to offset otherwise negative economic conditions finds that states with higher unemployment rates, states with spending that exceeds revenues, and states with higher individual income tax burdens are more likely to offer particular firms targeted subsidies. The results might explain the insignificant effects of incentives on growth: the weakest economies are using the incentives most intensively. — Calcagno, Peter and Frank Hefner. (2018) “Targeted Economic Incentives: An Analysis of State Fiscal Policy and Regulatory Conditions,” Mercatus Working Paper, Mercatus Center at George Mason University, Arlington, VA.
• Researchers examined whether there is a tradeoff between economic development incentives and economic freedom. They find an economically and statistically significant negative relationship between incentives and economic freedom, suggesting that incentives reduce economic freedom. — Op. cit., Dove and Sutter
• A study exploring whether targeted incentives are part of the set of government policies which might worsen income inequality in the U.S. finds evidence of a “reverse-Robin-Hood effect,” whereby income is redistributed from the bottom 90 percent of people to the top 10 percent of people. — Wang, Jia, Stephen Ellis, and Cynthia Rogers. (2018). “Income Inequality and Economic Development Incentives in US States: Robin Hood in Reverse?,” Review of Regional Studies, 48. 93-117.
• Political realities create the potential for the influence of politics over economic decisions. Targeted policies reward small, highly organized interest groups with concentrated benefits paid for by taxpayers, consumers and other competitors. Relative to the beneficiaries, the groups that pay for these targeted benefits are unorganized and diffuse, and so tend to find it costlier to resist these policies, even if the total costs exceed the total benefits. — Op. cit., Olson.

1. Barry Keating. Spring Seminar, April 12, 2018, Fort Wayne, the Indiana Policy Review.
2. Jason Arp, who represents the 4th District on the Fort Wayne City Council, introduced a resolution today asking the Allen County Income Tax Council to approve a blanket exemption on taxes for equipment purchased after Jan. 1, 2019. A May 22 public hearing is scheduled.
3. Matthew Mitchell, Daniel Sutter and Scott Eastman. “The Political Economy of Targeted Economic Development Incentives.” The Journal of the Southern Regional Science Association (2018).

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