Corporate subsidies are a negative-sum game. They foster crony capitalism, hurt productivity growth and inflict great harm on product market competition.
As soon as Amazon announced the location of its new headquarters, an intense media battle started on the rationality of the fiscal subsidies offered by the two chosen states to attract the new headquarters. Was it a good idea for New York and Virginia to offer $1.5 billion and $573 million respectively to stir Amazon’s decision?
In each of the two chosen locations Amazon will invest billions in infrastructure, employ as many as 25,000 people directly (and many more indirectly), and bring billions in new tax revenues. Even the generous fiscal benefits offered by the two locations seem small vis-à-vis the additional fiscal revenues the winning states will enjoy. After all, had Amazon chosen New Jersey over New York, the Empire State would have lost up to $14 billion in new tax revenues over the next 25 years. Why shouldn’t a state pay a fraction of these enormous benefits to secure Amazon’s headquarters?
While appealing, this argument is flawed and—as it turns out—self-defeating. When companies compete for customers, they have to offer better products or lower prices. They are forced to innovate and improve efficiency in production. In economist lingo, product market competition is not a zero-sum game (my gains are equal to your losses), but a positive-sum game (my gains exceed your losses). By contrast, corporate competition for state subsidies is a zero-sum game. Amazon is not going to be more productive in New York than in New Jersey –it will only pay fewer taxes. If companies are successful in pitting one state against another, they will end up paying no state taxes. As a result, the economy will not be one iota more efficient, and the rest of us will end up paying more taxes to make up for the revenue shortfall.
Competition for subsidies also fosters crony capitalism and hurts productivity growth. It fosters crony capitalism because it favors companies that are well-connected, rather than companies that are more efficient. A recent paper shows that companies are more likely to receive subsidies when they make financial contributions to political candidates in the state. Competition for subsidies also hurts productivity growth because it forces companies to dedicate time and resources to influencing the political choices, rather than innovating and improving productivity. Anne Kruger labels these wasteful activities aimed at obtaining privilege as rent-seeking. In many circumstances, all the subsidies obtained by companies are wasted in rent-seeking activities. In such cases, competition for subsidies is not simply a zero-sum game, but a negative-sum game. Thus, corporate subsidies are uneconomical.
Corporate subsidies inflict an even greater harm to product market competition. Not all companies can pit one state against another. A small grocery store cannot get the governor’s attention by threatening to move across state borders. As a result, small stores will face the full burden of local taxation, while large ones receive tax exemption and subsidies. Not only does this too-big-to-tax policy distort product market competition, it is fundamentally un-American. In 1773, Boston patriots threw British tea into the harbor to protest the tax favored status of the British East India Company, which was able to underact American importers not because it was more efficient, but because was tax favored. In other terms, the American Revolution started as a revolution against those large corporations that use their political power to distort competition to their advantage. In these cases, corporate subsidies are not only are uneconomical, they are also un-American.
Aware of the distortions produced by corporate subsidies, the European Union has explicitly prohibited them. Ireland cannot attract businesses by offering lower corporate tax rate to specific companies; instead, it can attract businesses by offering a low tax rate to all. This rule has prevented the worst forms of beggar-thy-neighbor fiscal policies
Paradoxically, a similar rule can also be found in the US constitution, as interpreted by the Supreme Court in Maryland v. Louisiana, 451 U.S. 725, 754 (1981):
“One of the fundamental principles of Commerce Clause jurisprudence is that no State, consistent with the Commerce Clause, may “impose a tax which discriminates against interstate commerce . . . by providing a direct commercial advantage to local business.” This antidiscrimination principle “follows inexorably from the basic purpose of the Clause” to prohibit the multiplication of preferential trade areas destructive of the free commerce anticipated by the Constitution.”
I am not a lawyer. As an economist, however, I can state with certainty that there is no difference between discriminating through taxes and discriminating through subsidies. I can also say that preferential trade areas and preferential treatment for some companies are equally destructive of free commerce. Hence, it is not unreasonable to argue that these types of corporate subsidies are even unconstitutional.
The problem is not Amazon or New York. Foxconn received a similarly outrageous subsidy from the state of Wisconsin just a few months ago. The problem is a system that with the pretense of helping business destroys free markets.
Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.