more of the same

Living in the northwest Chicago suburbs for the summer, it takes a while for my weekly subscription to The Economist to get forwarded to me from my Columbus address. Today I was able to do a little catching up on the May 20-26 issue. In this issue, there was a blurb about Cuno that began with a summary of the case and ended with a brief economic analysis:

Overall, [Ohio] collects taxes equal to 12% of personal income, according to the Tax Foundation: the third-highest tax burden in America, and more than a percentage point above the national average. Those poor saps, ordinary taxpayers, are the ones who fill the gap between incentives for business and consistently high state spending.

America's states would no doubt have better governance if they would stick to simple tax systems that are broad and fair, and then compete with neighbouring states by deciding how hgh or low to set their overall tax burden. Those acrobatic politicians, however, would never go for it.

My thoughts exactly. But similar to WSJ's coverage of the issue, The Economist missed an opportunity to adequately address an issue that needs to be covered. Rather than authoring a special report on Scotland and its relationship with the rest of the UK and devoting barely a half a page to the inequity of state tax incentives, couldn't the magazine done a special report on state tax incentives?

The answer is yes, The Economist could have written a few pages on tax incentives, but clearly the higher-ups there don't feel it is worth it at this time. And to be fair, The Economist is an English journal at heart, so it makes sense for them to write a full report on the Scots' problems which concludes that in politics, Scotland "shows little originality, exuberance or readiness or readiness to experiment...."

Perhaps the failure of due coverage is a window of opportunity.

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.

the problems

Each state, and locality, for that matter, sets up their business tax regime and with that a certain corporate tax rate. Theoretically, this rate should hold to each corporation who does business in State X, no matter how large or small the business is. Unfortunately, lawmakers see it as their duty to directly create jobs, rather than create the conditions that allow for optimum job creation.

From this premise, these lawmakers take credit when they grant companies (usually larger corporations) a break from the rates they had originally set. While it's great when companies are taxed at lower rates, in reality only the larger ones have access to these breaks.

I became intersted in this issue after learning about DaimlerChrysler v. Cuno. A May 16 Wall Street Journal editorial gave an good summary of the case. Cuno

concerned an Ohio law offering an investment tax credit and property tax abatements to entice [DaimlerChrysler] to build a plant in Toledo. Some taxpayers challenged the incentives arguing that they violate the Constitution's Commerce Clause. On behalf of the court, Chief Justice John Roberts wrote: "All the theories plaintiffs have offered to support their standing to challenge the franchise tax credit are unavailing. Because the plaintiffs have no standing to challenge that credit, the lower courts erred by considering their claims against it."

Some experts predicted correctly that the Supreme Court would dismiss the case on a standing issue and would not even get to the merits on whether states are allowed to offer tax credits under the Constitution. Not withstanding the standing issue, I believe that states are allowed to offer such incentives under the Constitution.

The problem is the economics behind this incentive. The same WSJ editorial commented that as "economic policy, we don't like incentives targeted at individual companies. Politicians are better off creating a low-tax climate that makes the whole state a business magnet." As the leading free market newspaper in the country, I felt, however, that the Wall Street Journal could have done much more to highlight the problem of individualized incentives. I let the WSJ know how I feel in an email:

Dear editor,

Your May 16 editorial, "Commerce-Clause Classic," was correct to point out that the Sixth Circuit's ruling in Cuno v. DaimlerChrysler was inconsistent with decades of precedent that granted states significant taxation power. But your paper failed to adequately address the key issue of tax incentives to large companies, mentioning only that "we don't like incentives targeted at individual companies. Politicians are better off creating a low-tax climate that makes the whole state a business magnet." This is a point upon which there should be much expansion. The tax incentives that companies like DaimlerChrylser receive for investing in states are unfair to smaller businesses who, without effective political clout, are unable to get the same treatment and must pay the standard tax rate. As a constitutional matter, states should be able to tax businesses at different rates. Economically speaking, the lack of uniformity in states like Ohio leaves much to be desired.

The editor did not respond and, suffice it to say, my letter was not published. But that which does not kill me only makes me stronger. Like any good American, I am now going to blog about the topic of states' individualized tax incentives.

first post

Today is the Sunday of Memorial Day weekend, 2006. My girlfriend, Katie, is in Wisconsin for a marathon, so I have a few hours to kill. I am using this spare time to create a blog entitled "A Taxing Issue."

Many of my friends run their own blogs, some good, some not so good. But I admire them all for doing so and I have always had interest in starting one up. I didn't want my blog to be about my personal life. If you want to get to know me, get to know me. So where does that leave me?

I'm going to be a third year law student at Ohio State beginning this August. I don't know what exactly I will do with my JD or what type of law I will practice. But I do know that certain things have interested me over the past few years: international trade, specifically import classification; property rights, specifically eminent domain and economic development; and the United States Constitution, even though I did awful in con law.

Recently, I have thought about state tax breaks and incentives. Those of you who know should do know how I generally feel about the topic. For strangers, I won't reveal that now but hopefully will make my position clear as this blog develops. Anyways, that will be the topic of this blog.

At this point, I am far from an expert on this topic and only know my gut feelings. Through frequent posts (at least weekly, hopefully), I plan on exploring many sides of the topic. I don't have any plan on comments or guest posts or anything like that. Actually, I don't have any sort of plan other than the topic I want to discuss.

I'm tired of writing this introductory post, so let's get started.