Monday, December 3, 2012

Can I Have Some Politics With My Investment Incentives?

. Monday, December 3, 2012

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:

One, [economist]  in Minnesota, used mathematical proofs and game theory to show that competition between states did not increase overall economic value. Several other economists have since called the practice a zero-sum game. 

Okay, let's unpack that a bit. Incentives inherently are inefficient because, best case, they induce a company to invest in a location that it otherwise wouldn't because doing so without the incentive doesn't make financial sense. If investing made financial sense, a government shouldn't need to offer an incentive in the first place. But, of course, the investor-government relationship doesn't exist in a vacuum. States and localities (not to mention other countries) are all trying to entice companies to invest within its borders. So, capital has leverage because it is mobile and governments will engage in competition with one another for the investment, ratcheting up the value of incentive packages. Story takes this as evidence that incentives are bad and should be curtailed. As a political scientist, the inefficient outcome is the starting point because it is puzzling: Why do governments offer incentives when they are inefficient? Story's answer seems to be "because tax consultants have corrupted the halls of power." This is an incredibly unsatisfying answer. Why did the tax consultants get so much political power in the first place? Why can't politicians just freeze them out?

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.



Nate Jensen said...

Thanks for the link to my work. But there is one good NBER working paper on incentives that finds more corrupt cities are more likely to offer TIF incentives.

Sarah Bauerle Danzman said...

Thanks Nate. And, thanks for the link. Looks like an interesting read. I don't mean to say that corruption doesn't matter at all. Just that it is not the only thing that matters, nor the most important one. While I'm glad that the NY Times is covering this topic, I wish that they could move beyond the "corporations are demanding tax breaks while also cutting jobs and you all should be outraged" narrative and toward a more nuanced discussion about the multiple factors that encourage incentive proliferation. Incentive policy raises really important and interesting normative questions about budgetary priorities. But the fundamental driver of incentive policy is not greed corporations (corporations are always greedy) or corrupt politicians (though they can certainly make the problem worse). The issue is more about how states create jobs in an increasingly integrated world economy. Where Story is at her best, I think, is when she discusses problems of state and local government capacity - a factor that is perhaps under studied in the extant political science literature on this topic (though that seems to be changing).

But, perhaps it is too much to ask newspapers to move beyond sensationalist frames. That's what academia is for, and that's why what we write has such narrow readership.

Can I Have Some Politics With My Investment Incentives?




Add to Technorati Favorites