States compete to give costly subsidies to businesses, a new study suggests that an interstate Compact will end this race to the bottom

When Amazon was trying to find a home for its new headquarters, different states came forward with incentives for Amazon to move to their cities. Among the incentives offered were tax breaks and cash grants. These incentives were in exchange for the anticipated jobs that Amazon was going to bring to those cities.

Amazon is not the first business to ever get incentives from states, nor is it the last. Routinely, states and cities provide what we call economic development subsidies to businesses. Politicians contend that without these subsidies, businesses would not move to their region — or expand existing businesses — and create jobs. So, subsidies, in a way are supposed to spur economic development.

The research, however, finds no evidence that these subsidies work. For the most part, subsidies do not have a significant impact on economic development. This is mainly because companies rarely make their decisions on where to locate based on subsidies. So, on the net, subsidies are almost always a loss to taxpayers.

So, why do lawmakers keep handing out these subsidies if they don’t work?

Subsidies are politically popular

Michael D. Farren and Matthew D. Mitchell, researchers at the Mercatus Center at George Mason University, set out to figure out a way for states to stop competing to offer these costly subsidies. According to their paper,  An Interstate Compact to End the Economic Development Subsidy Arms Race, there are three reasons why states might offer subsidies.

Firstly, many of the costs of subsidies are generally not considered or are undercounted before investment decisions are made. Secondly, taxpayers face greater difficulty in organizing to oppose subsidies than companies face in campaigning to maintain them.

But the third and main reason that lawmakers officer subsidies is that it is politically advantageous to do so, especially when politicians in other localities are doing so. What better way to get reelected than to create jobs? 

It starts to reason then that any solution to ending subsidies must restrain politician decision or prevent competition among politicians of different localities. And according to Michae D. Farren and Matthew D. Mitchell, an interstate compact can do that. If states and cities enter into compacts, they can refrain from offering subsidies to companies in an attempt to poach businesses from one another.

How the compacts would work

States would make agreements to refrain from offering subsidies that are intended to poach companies from one another. This would then reduce the negotiating leverage that most companies have over choosing a location. For instance, when Amazon announced that it was moving forward, states scrambled to present the best incentive to Amazon, probably in some cases disregarding the overall cost of those incentives.

If states had prior agreements, there would have not been competition, and Amazon would have had to consider other factors when deciding where to move. It is quite possible tax incentives were not one of the top factors Amazon would consider in order to choose a location. But the fact that Amazon was able to incite such competition between states helped it get extra handouts at the cost of taxpayers.

An interstate compact would save Minnesota taxpayers’ money 

Just in February of this year, the state of Minnesota provided $ 1 million in grants and loans to MinnetronixAn, a technology company based in St. Paul. The subsidy was intended to help Minnetronix add jobs and keep its headquarters in St. Paul.

And in 2014, the Minnesota Department of Economic Development created a special fund called Job Creation Fund. This is a “pay-for-performance” program that supports businesses after they meet benchmarks for new jobs and private investment. Since 2014, the fund has provided grants to 71 Minnesota cities. Part of the funds for the grant to Minnetronix came from this program.

With an interstate compact, Minnesota would no longer use taxpayers’ funds to give businesses handouts, potentially saving taxpayers tens, if not hundreds, of millions.