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Do incentives improve lives?

This week the Johnson Center released Improving Lives in Alabama. The book’s twelve chapters address policy issues like taxes, public schools, Medicaid and legal reform. The volume’s subtitle is A Vision for Economic Freedom and Prosperity, and we hope it helps map a course to a better future.

One of the most challenging issues the book addresses is Alabama’s use of incentives to recruit businesses. My Johnson Center colleague Dr. George Crowley tackles this issue, and his chapter’s subtitle – “Is Alabama Giving Away the Store to Attract New Industry?” – describes the dilemma. The state has used tax cuts and targeted expenditures to lure companies like Mercedes-Benz, Honda, Hyundai, ThyssenKrupp and Airbus to Alabama.

Dr. Crowley examines in depth five of these deals’ impact on the state’s economy. Although one deal was clearly a bust (National Rail Car), Mercedes, Honda and Hyundai have brought thousands of manufacturing jobs to the state. But the jobs have not come cheap; the Mercedes deal cost at least $250 million and created perhaps 3,000 manufacturing jobs. And Dr. Crowley found no spillover of manufacturing jobs to surrounding counties, and so the auto plants have not boosted entire regions of the state.

Alabama seems intent on doubling down on deals, with the legislature currently working on at least three bills to expand economic development incentives. Good evidence on whether targeted incentives help or hurt a state’s economy is sparse.

Several arguments suggest that incentive deals are poor public policy. First and foremost, job creation is not the task of government in a market economy. Government should provide the institutional foundation for the market by protecting property rights through the police and courts, and providing important public goods like national defense. State and local officials should only provide entrepreneurs a fertile field to grow the economy, not offer tax-funded incentives for businesses to do business. Many Alabamians, however, seem to look to government for job creation. But ultimately the private sector must create jobs.

Providing tax breaks to some but not all businesses also results in troubling unequal treatment. Equal treatment is a fundamental component of limited government and the rule of law. Politicians should not be able to make one person pay draconian taxes while exempting his neighbor.

Reducing taxes and regulations for all businesses is preferable to selective relief. State officials effectively admit that taxes and regulations on business are too burdensome when they offer concessions to businesses considering moving to Alabama. Excessive taxes and regulations combined with selective exemptions create an economy where politicians and not consumers decide which businesses survive and thrive. At a minimum, selective relief furthers a crony economy, in which businesses pursue political favors.

But good arguments also suggest that incentives improve the economy. Reducing taxes and unnecessary regulations lowers the cost of goods and services for consumers. And economic development incentives emerge out of competition between state and local governments. Competition is generally a positive force in society. Economists concerned about the potential excessive government specifically point to competition between governments as a means of increasing freedom. This is because people and businesses will move to nations or states offering greater freedom.

Alabama is not the only state offering development incentives, and we cannot make other states stop offering incentives. The situation is just like an arms race, and unilateral disarmament is often a poor strategy during an arms race. I would need another column, however, to discuss the questions raised by the arms race element of state economic development.

I think that economic development would be more likely to advance prosperity if the deals did not involve spending tax dollars on businesses, as this increases the potential for private gain at public expense enormously. Yet I would not want Congress to restrict states’ ability to use development incentives as some scholars have recommended. The prospects for economic freedom in Alabama I think would definitely be brighter if we did not look to state and local government for job creation.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. Respond to him at dsutter@troy.edu and like the Johnson Center on Facebook.

 

About Dan Sutter

I am the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University.

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