The New Civil War

Politicians and bureaucracies dangle irrational, wasteful subsidies to lure companies to relocate or stay put. At what cost?

When Parviz Parhami incorporated Scientific Applications and Research Associates (SARA) in 1989 in California's Orange County, he was surprised by the mail he received from officials in Nevada. "They sent me a condolence letter," he recalls. "It listed all the reasons that I should have incorporated in Nevada instead."

SARA has grown by 50% a year over the past four years and now boasts 30 employees and about $3 million in sales. Although Parhami believes he could not have built his company as rapidly anywhere else, he admits that Nevada's appeals and similar recruitment efforts from other states have him seriously considering moving his business in the future in exchange for an attractive subsidy package.

Parhami's experience is a minor episode in what might aptly be called a new civil war, an irrational and wasteful dangling of business-recruitment subsidies by headline-hungry politicians and the local bureaucracies that serve them.

You want a major episode? Consider Intel Corp.'s recent move to Rio Rancho, N. Mex. One of the nation's fastest-growing cities -- it grew from 10,000 residents in 1980 to 33,000 in 1990 -- Rio Rancho has offered some of the most aggressive relocation-incentive schemes in U.S. history. It is perhaps one of the new civil war's biggest casualties.

Rio Rancho made headlines in 1993 when it beat out cities in California, Texas, Oregon, and Arizona to become the new home for a prized $1-billion Intel semiconductor plant. Touting the need to compete with subsidized foreign companies, Intel had presented its multiple suitors with a 104-point "ideal incentive matrix" -- actually a set of tax, utility, workforce-subsidy, and regulatory-relief demands. Rio Rancho prevailed with a winning $114-million package. But almost as soon as the deal was signed, major problems surfaced.

Intel had been promised environmental regulatory relief as well as water (from what were billed as New Mexico's vast underground aquifers) to cheaply feed its water-hungry operations. When Intel applied for permits to drill several 2,000-foot wells, New Mexico officials belatedly discovered that the regional water table had precipitously fallen, forcing Intel to cut back its planned extraction by nearly 40%. What's more, noxious fumes traced to the plant caused skin disorders among local residents and led to sharp political conflicts with the community.

Rio Rancho again made headlines when it couldn't pay for essential public services, especially for schools for the many families it had lured to the sagebrush. In 1994, when the town created a new school district, it could raise only $27 million in taxes, far less than it needed to pay for its current, let alone future, educational needs. Rueful officials publicly admitted that they could have obtained 10 times more funding had Intel's decades-long tax holiday not been on the tax rolls. The new school board went begging for funds from an unsympathetic state legislature, using as props scores of local children wearing ribbons proclaiming, "We're desperate."

Eventually Rio Rancho announced that it had found a way to at least build a high school. In September 1995, after the community agreed to float an $8-billion industrial-revenue bond on behalf of Intel -- for an amount four times the entire annual state budget in New Mexico -- the chip maker offered to pay $28.5 million toward the new construction. Yet Intel's New Mexico external-affairs director, Bill Garcia, was careful to point out that Intel wasn't responsible for schools, noting that "we think that the state has to step up to its responsibilities."

Rio Rancho is hardly alone among communities dangling aggressive, potentially foolhardy incentive packages to lure businesses. Behind the most publicized incidents, countless cities, counties, and localities regularly undercut one another with alluring "economic development" campaigns. Despite the seemingly probusiness slant of those programs, the big losers are the very businesses and industries -- particularly in emerging sectors and growth companies -- such efforts are supposed to help.

America's multibillion-dollar new civil war shuffles industry from the country's most competitive high-skill, high-value-added regions to low-skill, less productive areas. It diverts political attention and resources from far more crucial public concerns and discriminates against existing businesses in favor of a handful of politically savvy, highly visible large enterprises. Above all, it creates an illusion of growth that conceals tremendous damage to the nation's overall welfare.

Today business incentives are themselves a big business. They have spawned an industry of private relocation consultants who pit mushrooming state-development bureaucracies against one another for their corporate clients. Reputable accounting firms rank each state's development bureaucracy so that everybody knows where to get the best handouts.

Then there's politics. Deals like the $250 million in public funds that lured the cellar-dwelling Cleveland Browns National Football League franchise to economically troubled Baltimore in 1995 make little economic sense.

A Winnerless War
Politicians and voters like business subsidies. And bureaucrats who get paid to run the programs and corporations that get the money like them, too. What's wrong with that?

Plenty.

The biggest problem is that most subsidies cost more than they produce. Studies of southern incentive programs, for example, show that as much as 75% of all payments went to projects that did not produce permanent jobs or produced jobs that the recipients would have done anyway.

What's more, American development officials are spending their billions without following any objective standards. Self-evident failures are just ignored.

One of the most obvious problems is that subsidy programs rarely produce jobs in the troubled areas for which they were originally targeted. The much ballyhooed Kentucky Rural Economic Development Act (KREDA), a leading business-subsidy scheme, was supposed to create jobs in the most backward Kentucky counties. Instead it funneled more than $1.6 billion in concessions to 173 corporations, almost all of which were located in the most urbanized, well-developed regions of Kentucky. That's typical of most state programs. They are initially justified to assist the particularly disadvantaged, but the money ends up in the pockets of those who don't need it.