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Good OM Reading: An Analysis of State-Provided Benefits in Location Decisions

June 3, 2014

Competing for businesses by offering companies targeted benefits is a popular policy among the governments of American states. As we discuss in Chapter 8, benefits come in many forms, including business tax credits for investments, property tax abatements, and reductions in the sales tax paid by the recipient businesses. Policymakers sometimes establish “enterprise zones” to facilitate these benefits, granting them to companies that hire people and invest in the zones. The purpose of benefits is to promote employment, innovation, economic growth, and revitalization.

Despite their good intentions, policymakers often overlook the unseen and unintended negative consequences of targeted benefits, according to a new study titled The Political Economy of State Provided Targeted Benefits (May, 2014). The paper analyzes two major, neglected downsides of these policies: (1) they lead to a misallocation of resources, and (2) they encourage “rent-seeking.” The authors, both at George Mason U., argue that these negative consequences of benefits are likely to outweigh any benefits.

Targeted benefits are by no means a new policy in the U.S. During the “railroad era” in the 1800s, many American cities provided subsidies to railway companies to attract their business. As railroad expansion slowed in the early 1900s, local governments’ role in luring particular companies to their locales diminished. But in recent decades, the trend has been a steady increase in the number of state governments offering various tax benefits to businesses. The 1980s has been called the “decade of industrial recruitment and state incentive packages.” Surprisingly many states do not evaluate their benefits programs consistently.

 The study examines the systemic effects of targeted benefits on market competition and the incentives facing both companies and politicians. It concludes that benefits cause a misallocation of resources as governments use them to change the composition of economic activity and to attempt to increase overall economic activity. It also finds they lead to cronyism as firms seek to secure benefits from the government.

 

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