A report from the battlefield

Overheard at "The Economic War Among the States" conference in Washington, D.C., in May:

• Things have gotten out of hand. Something needs to be done.

• This is not a war, it's a skirmish. There is not much damage.

• The choice is between giving money to business or giving money to those things that make for a better business climate, like schools and infrastructure.

• Some of you think economic developers are just a bunch of chamber of commerce boosters that say, "To hell with the future." It's not true, we don't want to sell the future down the river.

• I think most Europeans would look at the proposal to have Congress end these economic incentives and say, "Of course."

• I don't think it's likely, in the current political climate, that some action at the federal level will be taken; besides, do we really want the federal government involved in this?

Needless to say, when over 70 lawyers, economists, labor leaders, business representatives and public policy officials gather to discuss almost anything, there will be disagreement. And that was especially true when the issue at hand was preferential financial incentives that states and cities grant to private businesses. For some, those incentives are seen as essential tools that create jobs and help build strong economies for states and communities; for others, incentives simply move jobs around and ultimately erode an economy's foundation by reducing funding for schools and infrastructure.

But amid the dissension was consensus-a number of the attendees even expressed surprise at the amount of general agreement. For example, even among the staunchest proponents of the use of incentives, there was an acknowledgment that some deals are bad and that some form of public disclosure would benefit everyone, especially taxpayers. And many attendees, if not all, agreed that a public debate on the use of financial incentives was important, and that continuing education of policy-makers, the press and the public is necessary.

Thornier issues, though-like whether and how to limit states' use of incentives; the proper role, if any, for federal authority; and exactly how much information on incentive deals should be disclosed-were left unresolved. But the intent of the conference was not to necessarily find answers, rather, it was to raise questions and to elevate the discussion to a national level, according to Leonard Witt, executive director of Minnesota Public Radio's Civic Journalism Initiative, which produced the conference. "That's certainly what happened," Witt said, referring not only to the conference, but also to the Initiative's Web site and the programming on public radio stations. "It's up to the citizenry and the policy-makers to do with it what they may."

What's next? Conference offers suggestions

In an effort to prod citizens and policy-makers, conference attendees were put to work. Their task, in the end, was to present policy proposals, or "next steps," in response to six questions or issues. To begin this process, attendees first created a list of issues and policy considerations that reflected the concerns of their particular discipline, for example, the lawyers met together, as did the economists and so forth. In a general session those issues were then winnowed to six, with the help of hand-held, computerized voting technology. Those six questions were then submitted to reconstructed groups of participants that represented a mix of sectors. This second effort sparked considerable debate and ultimately led-with varying degrees of consensus-to the following specific policy proposals.

What can the states do to address the economic war among the states? The first of three proposals suggested by this group was, in part, suggested by other groups as well, and drew a mostly favorable response by the entire conference: full disclosure by government and companies during the bidding process. "If they're asking for public funds, it should be done in a public arena," says the group's moderator, Lee Munnich Jr., director, State and Local Policy Program, Humphrey Institute of Public Affairs at the University of Minnesota, Minneapolis.

Munnich is referring to the companies that are involved in seeking incentives, and he acknowledges that such disclosure would place a burden on those companies because they may have to release information that they would prefer to keep private, but he says the group's proposal would also affect the politicians and the "auctioneers," or those consultants who help companies decide where to relocate or expand. In particular, the group suggested that the role and compensation of auctioneers be released, as well as a list of political contributions by all players.

As to when disclosure should be made and exactly what information should be disclosed, the group had neither the time nor the expertise to solve, Munnich says, and he suggested that task should fall to state legislatures. But it's the question of those details that concerned some conference attendees. "No one is going to argue about the need for openness and accountability," says Kenneth Poole, director, Domestic Business Development for the National Association of State Development Agencies, Washington, DC But the dilemma is that private companies-with a vested interest in keeping certain information private-would balk at full disclosure, Poole says, making negotiation impossible.

Graham Toft, president of the Indiana Economic Development Council, Indianapolis, says that people who demand full disclosure throughout the negotiating process don't understand the nature of those negotiations. "This is public money and there is a big accountability issue, but you can't make the negotiation public; your prospects will walk away and just laugh at you," Toft says. He advocates, among other things, that states adhere to strict guidelines that measure the outcomes of incentives and that apply clawback provisions that require a company to repay its incentive if it doesn't meet projected job growth. This group also suggested that states form compacts to share information, create a model for analysis, identify legal technicalities and identify "best" and "worst" practices; echoing other groups, it also suggested that legislators adopt uniform standards and accountability measures.

How can decision-making and accountability be improved? Standards for awarding incentives, including an assessment of the quality of jobs, are necessary, according to Greg LeRoy, communications coordinator, International Brotherhood of Teamsters, Washington, DC Without an assessment of job quality, "Standards don't make sense," LeRoy says.

As Toft and others advocated, LeRoy's group also suggested that states develop some means of evaluating the performance of their economic incentives, that is, states should determine if companies are upholding their end of the bargain by creating a certain number and type of jobs. If not, some form of clawback should be invoked by the state, according to LeRoy, who says that an increasing number of states and cities are including such provisions in their incentive contracts. LeRoy also notes that he is not aware of any instance where clawback provisions are dampening businesses' enthusiasm for financial incentives.

This group's final suggestion-to convene a "blue-ribbon" board to develop voluntary reporting measures that would measure costs and benefits of incentives-is one that LeRoy says deserves attention because it may be the best way to implement uniform reporting standards. Even though these standards would be voluntarily enforced by states and cities, LeRoy said that pressure from the public and from credit rating companies would likely spur state and local governments to abide by the standards. The proposed blue-ribbon board would be staffed and funded, perhaps by foundation money, according to the proposal.

How do we develop better information on costs and benefits of incentives? To answer that question, this group decided that voluntary standards would not get the job done, and it advocated a federally mandated form to reveal certain information-for example, where funding goes, who pays (state, local or federal), prior location of the jobs if the new business is relocating, and impact on local employment, housing, schools and infrastructure. This proposal received lukewarm support among the whole conference because of the proposed federal mandate, and had opposition within the smaller group for the same reason, according to the group's leader, Kary Moss, executive director of the Maurice and Jane Sugar Law Center for Economic and Social Justice, Detroit.

But Moss doesn't think having the federal government involved is a radical idea, especially given that the problem is national in nature, that some federal funds are involved and that uniform standards across the board will make for better information. It's impossible to do good cost/benefit analysis, Moss says, without uniform and consistent information.

One of those in Moss' group who opposes federally mandated forms is Keon Chi, director, Center for State Trends and Innovations at the Council of State Governments, Lexington, Ky. "That is not something state people want to hear," Chi says about federal efforts in this area. He says that federal involvement is not plausible politically and is also not practical.

Still, Chi sees the need for states and cities to act on their own. Chi authored a 1994 report for the Council of State Governments-based on a 50-state survey on business incentives-that proposed five policy options, one of which would "subject the results of such policies to periodic quantitative measures." The Council's survey indicated that "only a few" states were using a formal cost/benefit model to analyze the impact of incentives, and the Council cited another survey showing that no cities employ a comprehensive cost/benefit analysis.

One thing the federal government could do, according to Chi, is provide the states with a methodology so they could do their own analysis-voluntarily. "This would be a big, big help," he says. States do not even have centralized methods of reporting on how all economic development funding is spent, let alone a method to evaluate the costs and benefits of such expenditures. "Governors come and go, bureaucrats come and go, so long-term planning is necessary," Chi says.

This group also suggested that a Securities and Exchange Commission-type disclosure be established to reveal specifics about each incentive deal.

What is the role of the courts and various levels of government? In an effort to focus attention on the issue and to establish data that could provide a springboard for further action, this group suggested that the Government Accounting Office-because of its reputation-should do a study on the impacts of preferential business incentives. The GAO's methodology could then be applied to other incentive cases, says William Schweke, senior fellow, Corporation for Enterprise Development, Chapel Hill, N.C.

"When a GAO study comes out, people pay attention to it," says John Donahue, professor at Harvard's Kennedy School of Government and a member of the group that was led by Schweke. And, to ensure that the study gets maximum exposure, Schweke says it should focus on an issue with broad-based understanding and appeal-sports stadiums.

Secondly, Schweke and Donahue's group proposed that state attorneys general "test the legal waters" and bring lawsuits challenging preferential business incentives. One of the reasons that governments use economic incentives is that the risks of doing so are low, Schweke says; that is, the costs of doing the wrong thing are not high enough. So, a good way to bring attention to the issue and to increase the downside risk of bad deals is to present legal challenges, he says. Such cases can be made by existing businesses that believe the state also owes them a financial incentive, by individual taxpayers claiming that their taxes are higher because of incentives, or by citizens who feel that deals which have gone sour have hurt their livelihood.

What goals and criteria should drive the use of incentives? This question was asked with the disparities between affluent and depressed areas in mind, and the group that reported on this issue suggested that before any action is taken, policy-makers should be educated on the all aspects of the issue. To do that, the group called for the establishment of reliable studies and data-much like other groups-and also for some consensus on the effects of incentives-are they zero-sum, positive-sum or negative-sum? Do incentives simply move jobs around and add nothing to the national picture? Do they bring new resources to a state in the long run because of increased employment and a growing tax base, and also, for example, because of infrastructure improvements made for a particular firm that also benefit the community at large? Or, do incentives actually hurt states and the nation by taking resources away from public use and giving them to private companies that would have created those jobs anyway?

Many attendees at the conference came with answers to those questions, and they left with the same answers, but there is still room for at least a working consensus on some issues, says Dan Kostenbauder, general tax counsel for Hewlett-Packard of Palo Alto, Calif. His group also called for more discussion on the question of global competitiveness and encouraged local decision-makers to consider their economic development issues in a regional and national context.

As a representative of the business sector, Kostenbauder was part of the group that raised the following question before the whole conference: "Is this issue really important?" The business group argued that the negative impacts of business incentives were exaggerated. Kostenbauder agrees that there are examples of bad deals that ultimately hurt certain states and cities, but he maintains that states are becoming more sophisticated in their deal-making, and besides, he says, states don't have an unlimited capacity to commit bad deals. They have limited funds and, by necessity, over time states will become smarter about the deals they make.

"Should the states not be able to do it? I have faith in the states' learning curve," Kostenbauder says. The education that states are gaining through trial and error, along with the "marketplace of the voting booth," will solve the problems associated with business incentives, Kostenbauder says. "I believe that."

But that doesn't mean Kostenbauder likes all forms of incentives. He noted that Hewlett-Packard, as well as much of the California business community, opposed a 1993 plan for the state to create a $250 million economic development fund on the grounds that it wasn't fair to existing businesses. Even though he considers such incentives an inappropriate use of public money, he doesn't think the federal government should jump in to ban such practices.

While Jim Rosapepe, delegate to the Maryland State Assembly, thinks that it is true that states will eventually learn the hard lessons about bad incentive deals, he says such an operating philosophy risks too much in the interim. It's like a person who smokes all his life, Rosapepe says, and then finally determines that it's bad for him-it may already be too late. There are choices being made at the state and local level that are having a real impact, he says-$200 million for a sports stadium means $200 million less for other projects.

Does the competition among states affect our global competitiveness? This question was of great interest among attendees, and is an issue that is gaining prominence, according to Indiana's Graham Toft. He says that companies involved in foreign markets generally operate on three levels: They may simply export from the United States, they may manufacture some products in another country, or they may be truly transnational with diversified operations throughout the world. He says he has seen Indiana companies advance through all three levels, and as they grow they look at the world for development possibilities, not just the 50 states. These companies are receiving large incentives from overseas sites, Toft says.

Thomas Holmes, professor of economics at the University of Minnesota, Minneapolis, led the group that investigated this question and he says there was some discussion about whether this topic was "overrated," because the large majority of the incentive deals likely involve state-to-state competition. Still, he says, the group acknowledged that capital is becoming increasingly mobile internationally, and incentive policies can impact a company's location decision.

But to counter international incentive competition, the group decided that the best thing states could do was not compete with incentives; rather, states should unilaterally disarm their incentive packages and focus attention on education and infrastructure. "If they do this unilaterally, this will be more appealing to business," Holmes says about the group's reasoning, because business will see the commitment to a quality work force and infrastructure system. Also, if a state remains committed to granting some form of preferential incentives, then it should not provide financial incentives but should only grant funds for education of workers and/or for infrastructure projects; that way, if the business were to fail or to move, the rest of the public would still have the benefit of the new road and the educated workers.

Holmes says that if a state would unilaterally agree to disarm their financial incentive packages, other states may see the benefits and follow the example.

The group's second proposal-to negotiate a "leveling up" of wages and other standards internationally-doesn't appeal to Holmes. "You can't legislate wages round the world," he says, but the group thought it was an idea worth considering.

In general, Holmes says he was surprised at the amount of support for a federal role in his group, and the group's third proposal addressed that willingness-Congress should require state attorneys general to issue opinions on the constitutionality of each subsidy or incentive.

Testing the courts

Many attendees at the conference reported that they were unfamiliar with the legal questions surrounding the incentives issue, and they took great interest in the reports given by the lawyers at the conference. As the policy proposals listed above indicate, some think the courts are ripe for a further testing of these issues. [Three papers (Frickey, Hellerstein, Kramer) review the legal questions and the case history relating to economic incentives.]

Earlier this year, in a much-watched case, William Maready, a North Carolina attorney, challenged that state's use of business incentives on the grounds that they violate North Carolina's constitutional ban on the use of public money for private purposes. Maready, who served as the plaintiff in the case, lost his argument before the state Supreme Court after winning before a trial court in Forsyth County, but the case helped raise the debate about incentives in a region of the country that has come to rely on such incentives as a means to compete with neighboring states. "The secretary of commerce cannot entice business to this state with one hand tied behind his back," North Carolina's state attorney general, Mike Easley, argued before the state Supreme Court.

At one point during the conference, when the lawyers were making their presentation, Walter Hellerstein, professor at the University of Georgia School of Law, reported that-according to the attorneys present at the conference-state tax credits that are limited to in-state investments are unconstitutional. In other words, a state can't tell a company that it will reduce its taxable income, but only if it invests within the state. Such measures restrict the movement of companies across state lines and are in conflict with the Commerce Clause. "That very thought created quite a stir among the nonlawyers in the audience," Hellerstein says.

Additionally, Hellerstein says that state legislatures and attorneys general are becoming aware of other potential legal problems, including whether states must reimburse other businesses within their borders that weren't given the same preferential incentives that a particular company may have received. "These questions are a wake-up call for state legislatures," Hellerstein says. He adds that a state should require something like a "legal impact statement" that must be reviewed by the attorney general before incentives deals are signed.

Hellerstein says legal challenges will likely continue against incentives. "When someone finds it in their economic or political benefit to do so, they will do it. The problem is finding the right plaintiff."

For Melvin Burstein, general counsel at the Federal Reserve Bank of Minneapolis, the conference served to reinforce his views about the legal questions surrounding the debate. It is significant to note that the lawyers at the conference were in agreement on all the main issues, Burstein says, especially regarding the interpretation of the Commerce Clause as it pertains to congressional power to prohibit preferential business incentives.

Burstein, along with Arthur Rolnick, research director at the Minneapolis Fed, argued in the bank's 1994 annual report that the courts are not an effective method to resolve the problems surrounding incentives, that states will not take action on their own, and that, hence, Congress should exercise its power under the Commerce Clause to end the incentives war. Still, there were some good ideas raised at the conference, according to Burstein, such as having state attorneys general bring suits against certain incentives practices; even so, he remains convinced that the courts are not an efficient means to remedy the incentives issue. Hellerstein agrees: "The courts are never the most efficient way of doing anything. But the courts may stimulate action to solve these issues in a systematic way."

Do winners really win? Can losers lose forever?

For Rolnick, the most systematic way to discourage or eliminate such practices would be for Congress to tax recipients of state incentives-at very high rates- or embargo federal grants to a state that uses preferential incentives. Congress has used such "disciplinary" measures in the past to attain its goals, for example, to encourage states to adhere to certain speed limits or to maintain certain pollution standards.

Other proposals don't go far enough, Rolnick says. Calling for state agreements to "disarm" incentive programs is a good idea in principle, but hasn't proved successful in practice; and advocating the enforcement of accountability standards doesn't end the practice of using incentive programs, it just means that the public will have more information-which is a good idea as far as it goes.

As for Burstein and Rolnick's proposal to have Congress end the "economic wars," there were strong advocates on both sides of the issue, largely divided along sectoral lines. For the most part, any proposals that were raised before the general assembly at the conference that suggested federal oversight did not fare as well as ideas that placed the onus on the states.

However, John Donahue of Harvard's Kennedy School of Government, says that interest in this issue has only begun to grow and Congress will likely address the topic in coming years. Many states are currently in good financial shape because of the recent steady growth in the economy, Donahue says, but as soon as the next recession hits and states look to their dwindling budgets, all eyes will then focus on the tax deals given to business, he says. "I wouldn't be surprised if within 10 years something like [Burstein and Rolnick] would pass," Donahue says.

Some at the conference said that competing claims from various groups about the ultimate effect of incentives brought some confusion to the subject-if we don't know if incentives are good, bad or zero-sum, how can we decide what to do? These people called for more consensus from economists. But Rolnick says there is general agreement from economists that incentives are a problem. Indeed, over 100 Midwestern economists recently signed a resolution advocating "an end to state-sponsored selective business incentive programs such as direct grants and targeted tax abatements."

But that doesn't mean that all economists agree on all aspects of the debate. Where economists don't agree, according to Rolnick, is on two levels: nationally, on the importance of the issue, that is, the degree of the problem; and locally, assuming there are winners and losers in the incentives game, how much do the winners gain and how badly are the losers hurt?

Joe Mattey, senior economist at the Federal Reserve Bank of San Francisco, has maintained that the concerns about economic efficiency are overblown, and he has argued that tax competition may even enhance efficiency. However, Mattey says one idea advocated by some at the conference may improve efficiency-making information known to all competing parties in a bidding process. This "cooperative" process may bring better outcomes than the current "competitive" process where auctioneers can keep certain information privy and thereby "ratchet up" the final deal, Mattey says.

Cooperation among states-whether to agree to share information or to voluntarily disarm from using incentives-was advocated by some at the conference at the same time that others rejected such agreements as wishful thinking. But those negative comments don't deter Jim Rosapepe of Maryland's State Assembly from advocating the use of noncompete agreements among states, and he looks for more states to take such measures.

"There's a difference between a good idea that's hard to accomplish and a bad idea," Rosapepe says. Agreements are a good idea, he says, and even though they are hard to monitor they are still worth doing.

It ain't over ... 'til the stadium issue is over

At the very least, Graham Toft thinks the "economic war" issue will remain in the spotlight as long as sports stadium funding remains prominent. "I think it's still a popular issue and will remain so," Toft says. "But how long? I don't know."

One conference attendee who is very familiar with sports stadium issues is Ohio State Senator Charles Horn. Cleveland lost its National Football League franchise to Maryland last year in a much-publicized move, and proposals are on the table to rebuild or upgrade other professional sports stadiums in Cleveland and Cincinnati. A former mayor as well as a business owner, Horn has been very active in working against public incentives for private business.

Horn's interest in the issue goes well beyond stadium funding. He recently attached an appropriation item to an Ohio budget bill to fund a $500,000 study of the state's economic development efforts, including an analysis of each of the business assistance programs, such as tax incentives, training and technology assistance. Horn also prepared a proposal for Ohio Gov. George Voinovich to present before a June meeting of the Great Lakes Governors conference to explore the possibility of creating cooperative efforts among the states "to mitigate the escalation of the interstate incentive wars."

Horn's Great Lakes proposal would have the states investigate ways to network technology, research and development, and university resources to improve the business climate of the whole region. "This will offer opportunities to invest in education and infrastructure, rather than giving money to the moving van," Horn says.

Marcia Howard, economic policy analyst for the American Federation of State, County and Municipal Employees, Washington, DC, thinks the issue will continue to grow in prominence and that, ultimately, some action will be taken at some level. She likens this issue to the discussions of wage inequality and corporate responsibility-a couple of years ago nobody said much about those issues, and now they've moved to the top of many policy-makers' lists. "I think this is something that will resonate," Howard says.

In the meantime, states will continue to compete for business using tax and financial incentives. In his report for the Council of State Governments, Keon Chi says that 38 states reported an increase in such activity during the five years prior to the survey. As for the five years following the survey: Of those reporting, 25 expect the use of incentive programs to increase through this decade, 22 expect the level to remain the same and only two thought activity would decrease.

This compares with almost a uniform increase among the states over the past 20 years, Chi reports, and suggests-at least-a leveling of activity. "Reasons for the decrease or leveling off in business incentive activities cited by the survey respondents were: budget constraints; reduction in small business incentives; reallocation of resources; and a decrease in funding levels due to reduced state revenue."

But perhaps one of the most telling responses to the Council's survey is why 47 states think incentive programs will continue, at least, on par with current levels: While states listed such factors as demand from companies, pressure from consultants, recession and special needs for special sectors or regions, "the most frequently mentioned reason is competition-competition with other states, often neighbors, or other countries in the global markets."

The competition referred to by those states is not for the best schools or the best roads, but competition for business through incentive programs. Which brings us back to the central question posed by the conference: What, if anything, should be done about this competition?

This paper, published by the Minneapolis Fed for "The Economic War Among the States," a conference held in Washington, D.C., on May 21-22, 1996, is reprinted in this issue of The Region.

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