Policy Innovation Memo: How to Stop the State Subsidy Wars

The Council on Foreign Relations’ Renewing America Initiative is releasing today our new Policy Innovation Memo “Curtailing the Subsidy War Within the United States,” which I co-authored with Associate Director Rebecca Strauss. The problem is a vexing one. Governors and state governments quite rightly spend an enormous amount of time and energy trying to attract job-creating investments to their states. They think about how to get the right mix of tax policy, education, infrastructure and sensible regulation that will draw business to their states. They compete vigorously with other states, and other countries, to sell companies on the merits of locating in their state. All of this deserves applause.

But sadly, that is rarely enough. Companies, especially large ones, are quite capable of playing states off against each other to extract millions in taxpayer dollars. Boeing, Caterpillar, Toyota and most recently the electric car maker Tesla are just a few of the companies that have played this game with great success. And so state governments are forced into bidding wars, offering special tax breaks, gifts of land or other subsidies to persuade companies to choose their state over others. It is a racket that costs states about $80 billion a year, which amounts to roughly seven percent of total state budgets. As Becky and I wrote in a New York Times op-ed that appeared on Saturday: “From a national perspective, this is about as dumb as it gets. Taxpayer money is wasted to pay off companies that would most likely have invested somewhere else in the United States.”

Figuring out what to do about these bidding wars is a whole lot harder. The easiest solution would be for the federal government simply to ban such subsidies. As one correspondent put it to me after the NYT article appeared: “Your op-ed takes the long way ‘round.” There is a solid legal argument to be made that Congress has the constitutional authority to forbid state subsidies, and current practices may well violate the Commerce Clause. The European Union, which in most respects is much less centralized than the United States, has a “State Aid” law that severely restricts the sort of subsidies that members states like France and Germany can offer to companies.

Sadly, after considering these options, we concluded that however strong the legal case for federal pre-emption, the political likelihood of this happening in Congress as it is currently configured is about one-in-a-bazillion. For purposes of economic development, U.S. states these days are almost like independent nations, with the federal government doing little or nothing to stop states from bidding freely for business. So, much like independent nations, states will only end the handouts if they voluntarily see the benefits of cooperation.

That is what made us look at international models of cooperation, such as those in the World Trade Organization (WTO) and the Organization for Economic Co-operation and Development (OECD). Surely if sovereign states can see a collective interest in rules that restrict subsidies–however imperfectly they are enforced–then U.S. states should be able to do the same.

Our report sketches out a model for how this could work, starting with greater transparency on what states are currently spending, and building up to regional pacts in which states agree to curb their subsidies if others do the same, while remaining free to compete with other states that refuse to abide by the rules. We suggest several ways the federal government could help. We do not underestimate the difficulty of this. It will take political courage for state leaders to take the first step. It will involve complex negotiations. Subsidies are not always easy to define, and some subsidies–say community college training geared to the specific needs of a large employer–are clearly desirable. And it could easily fail–a similar push in the early 1990s by Illinois governor Jim Edgar came to naught.

But the alternative is continue large and wasteful subsidies that are likely to become even larger and more wasteful. As we put it in the NY Times piece: “The only way for states to stop corporations from playing divide-and-conquer is to figure out ways to work together.”

This piece is cross-posted from CFR.org with permission.