“Select Incentives,” Crony Capitalism and Economic Development

By Mississippi Center for Public Policy
July 3, 2018

Since the inception of the Balance Agriculture with Industry (BAWI) plan, the State of Mississippi has provided private business enterprises with billions of dollars in taxpayer-funded subsidies. The argument advanced by the proponents of selective or targeted incentives is that the benefits of subsidies (i.e., more employment, higher wages, more tax revenue to state and local governments) in luring companies to locate in Mississippi are substantially greater than their costs. As discussed earlier, forecasts of the total economic benefits anticipated from business subsidies are based on projections of employment gains and promises of higher wages paid by the targeted businesses. Through a Keynesian multiplier effect, these employment and wage gains will spill over to other areas of the economy and create even more employment opportunities and higher wages.

However, the employment projections rarely become reality because the models used commonly to estimate the multiplier do not account for the job displacement effect, instead assuming contrary to fact that every person employed at the subsidized plant is a new addition to the workforce and that every dollar paid to those employees (the plant’s total payroll) adds to the income earned by residents of the state. Our simple graphical analyses in the previous section show clearly that the promised job gains from the Nissan’s Canton, Mississippi, plant fell far short of those projected ex ante. However, even if the benefits of a taxpayer-funded subsidy did outweigh the costs using standard measures of economic impacts, such an outcome would be a necessary, but not sufficient condition for concluding that the incentive package passes a benefit-cost test, thereby delivering net economic benefit (benefits > costs) because the analysis fails to consider the subsidy’s opportunity cost. One opportunity cost of a taxpayer-funded subsidy is the private-sector economic activity that would have been generated (but is lost) had the subsidy not occurred and the dollars allocated to it remained in the hands of private individuals and commercial businesses. As just explained, an additional dollar injected into the private sector is exchanged repeatedly in series of market transactions and thus creates economic value greater than the initial dollar. The converse also is true: Every additional dollar of tax revenue taken from the private sector reduces economic activity by more than one dollar.

The true cost of a taxpayer-funded subsidy to business therefore is not just the actual dollar amount of the subsidy, but rather the actual dollar amount of the subsidy plus lost private-sector consumption if the subsidy resources were to remain in the private sector. This observation suggests that the true economic cost of a taxpayer funded subsidy is much larger than the subsidy’s accounting. So, for example, in the case of Nissan’s Canton plant, the true economic cost per worker actually exceeds the $203,125 accounting cost presented earlier because in order to finance the $1.3 billion subsidy, economic activity in the private sector will fall by more than $1.3 billion (the multiplier effect working in reverse). The economic criterion for a subsidy to generate a positive net benefit is that those benefits must be greater than the dollar value of the subsidy plus the opportunity cost of the lost private sector consumption.

A business subsidy inherently assumes that every dollar of a taxpayer-funded subsidy is worth more to the economy than if the dollar remained in private sector hands. While this may be true in some cases, the academic research and evidence presented herein suggest that possibility is more the exception than the rule. So, as was discussed in Chapter 3, public officials who advocate for taxpayer-funded subsidies to business are implicitly claiming that they know better than do private individuals and firms interacting in free and open markets how to most effectively allocate resources to their highest valued uses. If that actually were true, then we should allow legislators and public officials to decide all business activity within a state. But, we have seen throughout history (the former Soviet Union, Cuba, Venezuela, and North Korea immediately come to mind) how poorly planned economies perform. Of course, the argument is not being made here that taxpayer-funded subsidies to lure businesses to Mississippi and other states is equivalent to having a planned economy like the aforementioned countries, but the difference is only a matter of degree. Even though less economic planning occurs in the United States than in other nations, planning fails wherever politicians and public officials displace market processes because they lack the information (price and profit signals) and incentives necessary to decide which economic activities merit encouragement and which do not.

Legislators and other public officials who support taxpayer-funded subsidies likely do so with the best intentions — to create greater economic opportunity and a better future for the citizens of their respective cities, counties and states. However, despite these best intentions, it is likely that, in most cases, taxpayer-funded subsidies will do more economic harm than good, in part owing to ignoring the opportunity cost of lost private-sector consumption. That harm is amplified because officials everywhere compete with one another to assemble incentive packages that will entice businesses to their respective jurisdictions. Such competition for business creates ever larger taxpayer-funded subsidy packages that likely will cause even more substantial net economic losses for society as a whole. The only way to stop this race-to-the-bottom is for public officials to stop offering selective incentives to businesses and instead foster a more favorable economic environment for all business activity, which includes companies already doing business in a state, whether large or small (e.g., lower taxes on citizens and businesses across the board, control over-excessive and wasteful government spending, promoting a skilled workforce, and minimal regulation). The free market, rather than politicians and bureaucrats, will then decide where business activity will locate.

We think that, in order to promote prosperity, all states and localities should abolish their economic development agencies, thereby saving the budgetary costs of official salaries, benefits and travel expenses to visit and cut deals with companies looking to move or to build new plants. Unilateral disarmament in the vigorous incentives arms’ race triggered by Mississippi during the Great Depression may, of course, cause the state to lose opportunities to lure big-name employers in the short or medium term. If an announcement that the Mississippi Development Authority has been shut down is paired with a dramatic cut in state business income taxes, however, the negative impact on revenue will be at most short-lived.

Here’s a chance for Mississippi to lead the nation forward with much better effect than its adoption long ago of the Balance Agriculture with Industry program. State officials may then realize that they all are made better off by disarming because selective incentives only shift economic activity around geographically and do not foster prosperity. On the surface, interstate competition for business location is a zero-sum game: one state’s gain is another’s loss. But, looked at more deeply as we have done in this chapter, the arms’ race is a negative-sum game because the ostensible benefits of the competition in terms of job gains, whether direct, indirect or induced, are less than the costs imposed on the private sector, thus hindering economic growth and prosperity in all states, including Mississippi.

This is an excerpt from “Selective Incentives,” Crony Capitalism and Economic Development by Thomas A. Garrett and William F. Shughart III. It was published in Promoting Prosperity in Mississippi.


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