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Should we ban states and cities from offering big tax breaks for jobs?

Nevada Governor Brian Sandoval (front R) reaches to hug Nevada Assembly Speaker Marilyn Kirkpatrick after he signed an incentive legislation to secure the Tesla Motors Gigafactory, during a ceremony at the state capitol in Carson City, Nevada September 11, 2014. (REUTERS/Steve Keegan)
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Tesla announced earlier this month that it's planning to build a $5 billion lithium battery factory just outside of Reno, which sounds good for Nevada and bad for losing bidders California, Texas, Arizona and New Mexico. So how did Nevada beat out so many competitors?

The state offered the electric-car maker up to $1.3 billion in tax breaks and subsidies in exchange for the highly coveted "gigafactory," which lawmakers hope could bring 20,000 jobs and $100 billion in economic impact to the state over the next 20 years. Governor Brian Sandoval declared that the deal had changed the state's trajectory. Nevada legislators unanimously approved it. "This is arguably the biggest thing that has happened in Nevada," one of them said, "since at least the Hoover Dam."

Yet in an alternate universe — one where states don't go to economic war over tech companies, corporate headquarters or auto plants — it seems logical that Tesla would still have to build its battery factory somewhere (maybe even Nevada). And if everyone weren't bidding for the facility, setting off an arm's race of tax abatements and public subsidies, no one would have to pay them.

This is the dream of critics who've decried Twitter's tax breaks in San Francisco, or Boeing's demands in Seattle, or IBM's dealings in New York: What if we simply banned states and local governments from poaching jobs from each other, or giving tax dollars to private corporations, or enabling what Greg LeRoy at Good Jobs First calls "job blackmail"? Wouldn't every state and municipality be better off if none of them had to pen costly deals to lure companies that might come anyway, or to quiet existing employers who threaten to leave?

By LeRoy's count, the practice has only escalated since the recession, as the political prize of "creating jobs" has grown even more valuable (never mind if they were "created" first elsewhere). Two years ago, the New York Times' Louise Story ran a scathing investigation of companies that have "increasingly exploited" fear of job losses in local communities, wresting, by her count, about $80 billion in incentives each year from them. Some of the worst-hit communities shelled out big-time to lure auto plants, only to have those same auto plants shutter during the recession.

See the full table.

Economists have repeatedly concluded that the incentive game is zero-sum: Most jobs and economic development created by incentives in one state or community are simply lost in another. It's also exceedingly difficult to pin down data on whether a public investment to lure a company is ultimately worth it. While there's often big fanfare around the announcement of such deals, there's seldom much attention on assessing their promises in hindsight.

"Even if a jurisdiction says, 'Well we have to do it because the other folks are doing it,' no, actually, you don’t," says Mark Funkhouser, a former mayor of Kansas City who is now the director of the Governing Institute. "Go ahead and let them take the poison. It doesn’t increase job growth."

Unilateral disarmament is a tough political proposition. As a systemic solution, Funkhouser advocates instead some kind of national law, what he loosely envisions as a domestic equivalent of the Foreign Corrupt Practices Act, which bans bribes of foreign officials to obtain business. At the very least, he says, we should hold accountable officials and chief executives who promise jobs and economic gain — for which a community has paid dearly — that never materialize.

"When somebody misrepresents what will happen in government finance to the tune of tens or hundreds of millions of dollars, that’s a fraud," he says. "When I look at what happened to Robert McDonnell for a whole lot less than I what see happening across the U.S., it’s amazing."

Neighboring states or communities sometimes reach their own economic development truces. Kansas and Missouri are now trying to disarm a bitter border war in the Kansas City metropolitan area, where companies have regularly extracted public concessions to move only a few miles. But the problem with any deal between neighbors is that there are always other neighbors, on the other side of the state, or elsewhere in the region, or — in the case of R&D jobs clustered on both coasts — on the other side of the country.

The only actor who could really resolve this is the federal government. But, says LeRoy, "There’s been no federal leadership on this at all, ever."

And, as Nevada's unanimous vote indicates, there's not much political will from politicians to dismantle this system. After all, they get to announce job deals today, but they may not still be sitting in office when it comes time to evaluate them. Funkhouser wasn't originally a politician. He was the city auditor in Kansas City, where what he saw in the deals he evaluated drove him to run for office.

He found virtually no use of incentives in lower-income, minority parts of town where incentives might legitimately be needed to correct market failures (creating affordable housing, for instance, where there is none). Where incentives were used to create retail hubs or high-end apartments, Funkhouser watched an escalating suite of incentives costing the city more and more: tax increment financing (or TIFs), then super-TIFs, then super-TIFs paired with city-backed loans.

"You can have economic development," he says. "But there has to be a clear public purpose, there has to be a clear market failure, and there has to be consequences for fraud."

LeRoy also adds that he's not out to outlaw all economic development.

"We’re not against incentives per se. The trouble is we don’t use the word 'incentives' very accurately," LeRoy says. "An incentive is [for] something that should happen but isn’t happening, that won’t happen unless taxpayers get involved: bringing a grocery store to a food desert, helping an ex-con get a job, cleaning up a brownfield. If you spend public money to do those things, those are worthy incentives, not subsidies, windfalls or giveaways."

LeRoy doesn't realistically expect any federal law any time soon. But he suggests a more modest alternative. In the mid 1980s, the federal government threatened to withhold a share of federal highway funds from any state that didn't enforce a legal drinking age of 21. We should do the same today around economic development incentives, LeRoy says: withhold 10 percent of some coveted federal funding stream — maybe Community Development Block Grants — from states that actively poach jobs from each other.

He calls it the "small carrot model," although others would probably see his plan as wielding a sharp stick.

So what would happen in this new world without interstate (or inter-city) economic warfare?

"We had a world in which this didn’t exist," Funkhouser says. That world lasted up through about the 1970s, by his metric. "We invested in the Interstate Highway System. We spent money on stuff that actually does create jobs: investment in infrastructure and investment in education. You need to have tools, excellent port facilities, excellent highways, and you need a highly skilled workforce. We have taken that money and shifted it away from the real generators of economic wealth and we’ve given it to people to line their pockets.

"If a state said, 'No, instead of $3 billion for Boeing, we’re going to invest it in schools, and we’re going to invest it in highways,' they would win," he says. "Nevada did not win on Tesla."

The economist is probably ready at this point to raise a few complications. LeRoy and Funkhouser's vision suffers from some definitional challenges: How do you separate a clear public purpose from a dubious one? Where do you draw the line around acceptable incentives to ensure that the food desert still gets it grocery store? If we're going to punish for "fraud" chief executives who promise jobs they never deliver, what role does that leave for an economy that tanks beyond his control?

There's also a massive measurement problem baked into the entire economic development industry: How do you actually assess whether incentives work? The answer — at least when we bother to ask for it — depends on so many assumptions. Would the company have come to town anyway? How do you quantify lost tax revenue it never paid? Should we assume that each job created yielded two more? Or three?

And the biggest challenge to designing any effective prohibition may be this: If we banned jurisdictions from offering tax breaks to lure companies, they'd probably find other ways to do it. First and foremost, states have widely varying corporate tax rates, which they also tout to lure business.

"It’s difficult to divorce incentives from taxes," says Daniel Wilson, a research advisor in the Economic Research Department at the Federal Reserve Bank of San Francisco, where he has analyzed incentives. "This is completely unrealistic, but the only way in my opinion that this kind of harmonization could work is if Congress passed a law that all 50 states have to have harmonized tax systems. And Congress could define how far they want to go with harmonization."

But that's a radical idea that would upend a fundamental premise of how the country is structured: The states are supposed to be different. And, to some degree, you should be able to decide as a would-be resident if you want to live in a high-tax, high-amenity state, or a low-tax, low-amenity one.

Wilson's own research reinforces the criticism, from a national perspective, that all these local incentives are zero-sum. But it's hard to see, then, what to do about them. "It's a very intractable problem," he says.

Funkhouser acknowledges that he's not the best person to work out implementation for a national law. But he suspects the tide is turning, and that other people will begin to take this up, too.

"It reminds me of when tobacco companies said smoking didn’t cause cancer," he says. "You can get away with that for two or three decades. But eventually the dead bodies pile up. People now know that’s [expletive]. This is very similar to me. A whole lot of people are spending a whole lot of money to convince you this is a good idea."