On Sunday, The New York Times unveiled the first of a three part "investigation" of investment incentives in the United States. The story has generated a lot of media chatter, and caught my attention because I actual study investment incentives, albeit within the context of developing non-democratic regimes. I plan to write a series of posts directly engaging with the Times reporting, and I want to start with a short post laying a critical framework.
The report finds that states and local governments in the U.S. provide, on average, a combined $80 billion in investment incentives each year. The author, Louise Story, frames the issue as a tradeoff between incentives and broad-based government spending; investment incentives amount to a transfer from workers to businesses. Today, the second part in the series focused on Texas's incentive program (it's the biggest in the country), and blames its excess on the close relationship between a tax incentive consultant G. Brint Bryan and basically every elected official in the state of Texas. Tomorrow's installment will focus on incentives for the entertainment industry.
As someone who studies this stuff, I'm glad it's receiving national attention. The New York Times released a database cateloging the investment incentives, which I along with many others will be glad to use for our own research purposes. Yet, there are some real weaknesses with Story's analysis. And, while she mentions economists who have concluded incentives are inefficient, she never once sources good work in political science about the political motivations for providing incentive packages.
The closest Story gets to a political explanation for incentive programs comes when she mentions academic research that concludes incentives are inefficient:
Indeed, there is actually a decent amount of work in political science devoted to understanding incentive programs and policies toward foreign investment. Nate Jensen has a really neat working paper along with several other authors in which they use experimental data to show that U.S. voters reward governors who offer firms incentive packages and punish those who don't. Sonal Pandya finds workers, and in particular skilled workers, are more inclined to support efforts to attract foreign investment. At a global level, the lack of an institution governing investment policies is routinely pointed to as the source for recurring prisoners' dilemma-type dynamics. Politicians provide incentives because the localities with which they are competing for investment provide them and because their constituents reward them for doing so. You don't need a story about corruption to understand the dynamics perpetuating incentive programs.
I mention this because I don't think the corruption meme is helpful. What drives the high value of investment incentives in the US is fiscal federalism. If the Federal government had authority over taxation and investment incentives, states wouldn't be able to use the tax code to compete against each other. This is a distinction that is lost in the New York Times report. Story finds it bizarre that, amid a national discussion about austerity and government debt there hasn't been a sustained discussion about investment incentives. Well, investment incentives happen at the state and local level, so it's unsurprising that dicussions about the national budget don't normally veer off in this direction. Moreover, investment incentives, for the most part, do not generate budgetary outlays - a point Story obscures in her reporting. Of the $80 billion in incentives offered each year, $70 billion are in the form of income and sales tax exemptions or reductions. Sure, this $70 billion can be considered lost revenue, but it doesn't amount to spending and it is also difficult to determine exactly how much tax incentives cost because firms often argue that they would not make an investment without the incentive. When governments do provide incentives that require budgetary outlays, mostly in the form of loans, a national discussion often ensues (remember Solyndra?).
In all that, I have hardly touched the global conditions that affect policies toward investment. I'll discuss that further in a follow-up post.