race to the bottom

The Economics Trends blog recently discussed Cuno and the problem of tax incentives. I agree with much of this particular blog, including the questionable claim of legislators that they create jobs through these tax incentives.

But one thing I don't agree with is the following passage that summarized the Cuno plaintiffs' claims:

These groups see the tax competition inherent in these state practices as part of a "race to the bottom", which ends up harming the local tax base and enriching corporate coffers. (And they are probably right.) They are raising a challenge under the Commerce Clause, contending that this practice discriminates in favor of companies locating in their state.

Whoever created the 'race to the bottom' jargon is a genius, albeit wrong. The race to the bottom is basically the idea that, when one municipality offers a tax break to a company, that ends up displacing smaller businesses, tax revenue that could have been generated, and other things that are valuable to society. The most important patr of the race to the bottom is that to compete with Municipality A, who offered the first tax break, Municipality B will have to do the same thing or offer an even greater tax break, and thus begins an endless cycle of tax breaks, massive job displacement, and pure chaos; in short, it is a race to the bottom.

The race to the bottom idea is also used when discussing free trade agreements. But whatever context the race to the bottom idea comes up in, its premise is wrong.

It is true that when a city or state goverment offers a tax break to a major corporation, smaller companies are often the victims and city or state coffers do not receive the corporate income tax that they would otherwise receive. But if it truly were a race to the bottom, then local governments would not engage so often in this practice. How do local governments win through tax incentives? If the larger corporation actually displaces the small company, that will usually mean more jobs for the locality. Those jobs might be better paying, which could help to alleviate the tax revenue that the local government doesn't receive due to the tax break. Furthermore, just because a corporation does not contribute much to a city's tax base does not mean they don't help in other ways. Corporations are smart and they will engage in all sorts of activities to establish goodwill with the citizens they employ and with which they share an area.

The point behind the fallacy of the race to the bottom is that when localities offer these tax incentives, societal wealth does not just disappear. Instead, local governments just do not have as much access to the wealth as before and, all else being equal, this is probably a good thing.

I am all for wealth maximization and when it comes down to it, tax incentives to corporations likely do increase wealth on the aggregate. The question is whether governments should be in the business of offering individualized incentives to corporations or would everyone be better off if governments merely offered a low, uniform rate that everyone was entitled to.