December 4th, 2012
01:24 PM ET

Cracking down on our wasteful subsidies

By Edward Alden, CFR

Editor's Note: Edward Alden is a senior fellow at the Council on Foreign Relations. This entry of Renewing America was originally published here. The views expressed are the author’s own.

Two decades ago, the United States demanded that other countries in the World Trade Organization (WTO) agree to significant restrictions on “trade distorting subsidies” of various sorts, such as government grants, tax breaks, or other benefits that would allow companies an unfair advantage against others in the international market. All well and good, but as the proverb has it: “Physician, heal thyself.”

According to a remarkable new database of state government subsidies to business compiled by the New York Times, the fifty state governments are currently offering more than $80 billion each year in incentives to persuade companies to locate or expand in their states. The subsidies take many forms, but the most common are special reductions in taxes to well below the rates that are paid by other companies in the state. While the existence of such location incentives is hardly a secret, the numbers are shockingly large. Texas tops the list, spending more than $19 billion per year on corporate subsidies, and some 48 companies, led by General Motors, have received more than $100 million in subsidies since 2007.

The subsidies are hard to defend on any rational grounds. The costs in lost tax revenue are significant – Texas last year slashed $31 billion in spending to close its budget deficit, including a 13 percent cut to a public education system that was already among the most poorly funded in the nation. There is no net benefit to the country – most of the companies are either relocating from other states or would have built new operations somewhere in the United States regardless. While the incentives do sometimes lure investment away from other states, in many cases companies would have made the same decisions anyway, so the state government is simply wasting taxpayer money. And in other cases, as the Times documents, the companies quickly pick up and leave when business conditions change or a better offer comes along.

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While the collective impact is harmful, it is easy to understand why such practices persist. If every other state is offering such incentives, it is hard for a few states to take the moral high ground and refuse to play the game. The promise of new jobs – however costly and perhaps fleeting – is a powerful motivator for any state, especially in a weak economy like the one that still persists.

Subsidies wars are economic foolishness, which is why the United States has tried so hard to use the WTO and other international trade rules to restrict them in global trade. Some of the subsidies identified in the Times’ database could probably be fodder for WTO dispute settlement cases. A number of the largest recipients – including GM, Ford, General Electric and Boeing – are either big exporters or compete with imports. The issue of state subsidies, indeed, has been one of the big ones in the long-running Airbus-Boeing dispute in the WTO. But a successful WTO case demands that some foreign country prove that its companies have been harmed by the U.S. state subsidies. In most cases, the only victims here are other taxpayers, recipients of state government services like public education and Medicaid, and the states that lose the bidding wars.

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It’s time to create a domestic counterpart to the WTO dispute settlement system in order to bring the subsidies wars to a halt. The principles are already well laid out in the WTO, and the European Union has long had its own internal procedures for restricting what it calls “state aid” that distorts competition within the EU. The United States, in striking contrast, has no regulatory regime restricting state or local subsidies. There are three basic requirements: a legislative framework, an adjudication body, and penalties.

Legislation: The U.S. Congress should pass legislation that puts in place domestically many of the rules of the WTO’s “Agreement on Subsidies and Countervailing Measures.” The bill would distinguish between prohibited “specific” state subsidies to companies – such as tax refunds or reductions, cash grants, loans or loan guarantees – and permitted government expenditures such as infrastructure, job training, or across-the-board corporate tax reductions that are broadly beneficial to business.

Adjudication: The federal government should establish dispute settlement panels, under the authority of the Federal Trade Commission. States would be allowed to bring complaints in cases where they believe they have been harmed by prohibited subsidies offered by other states. Much as in the WTO, panel decisions would be binding, though an appeal mechanism to domestic U.S. courts would need to be created.

Penalties: The most obvious remedy is that the tax break or other prohibited subsidy would need to be withdrawn immediately. In the EU system, there is also a provision that can require the companies to pay back the subsidies. Another possibility could be a cash penalty that the offending state must pay to other states that were harmed by its actions.

The particulars would obviously take a lot of negotiation, and there may be constitutional issues, though this would seem to fall clearly under the federal government’s power to regulate interstate commerce. But the politics should be easy – Democrats should readily favor an end to corporate tax breaks that rob state governments of revenue, while Republicans should readily support an end to government interference that distorts competition in the market.

While some states would protest, and the beneficiary companies would surely object, there would be benefits all around. The states would stop wasting money they don’t have to waste, and the companies could get back to focusing on making quality products at reasonable prices rather than lobbying state governments for sweetheart deals.

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Topics: Economy • United States

soundoff (2 Responses)
  1. marc

    The claim of unfair subsidies is TOTAL hypocrisy: we are the sole printer of the world currency, this enables us to finance like no one else. QE I II etc. is a SUBSIDY and totals trillions of dollars which makes all other subsidies combined look pitifully small.

    Moreover, foreign countries have no real place to park our currency anywhere but back into our financial systems, treasuries, stocks, etc. This lowers interest rates and is in effect a forced giant subsidy of poorer countries to us. Bottom line – it is easier to capitalize and find financing here than anywhere else in the world. No wonder others need state support. The fact that we squandered a lot of our advantage is not anyone else fault but our own.

    December 4, 2012 at 3:09 pm | Reply
  2. Kenneth Thomas

    Good article. I've been calling for a federal solution since my 2000 book, *Competing for Capital* and pointing out that the EU system works very well. The Times series will help us with transparency, so probably the next step is to ban relocation subsidies from one state to another as the first article in the series featured in the Kansas City, MO/KS metro area.

    http://middleclasspoliticaleconomist.blogspot.com

    December 5, 2012 at 12:28 am | Reply

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