B R U N O R I C H A P T E R 3

INTERSTATE COMPETITION FOR ECONOMIC DEVELOPMENT

IMPORTANT CONCEPTS FOR UNDERSTANDING INTERSTATE TAX COMPETITION FOR ECONOMIC

DEVELOPMENT

1. Interstate competition in general, and tax competition in particular, is a fact of life in the United States.

2. Not all forms of interstate competition are equal.3. Political bias is built into the most pernicious type of

competition: targeted tax incentives. Such tax incentives, which are inequitable, inefficient, and largely unnecessary, violate virtually every principle of sound tax policy and good government.

WHY STATES COMPETE

• State As Sovereigns• States can govern as they wish, within the limits imposed by the federal

and state constitutions.• The commerce clause of the U.S. Constitution prevents states from

engaging in overaggressive competition by ensuring that states do not impose greater tax burdens on out-of-state companies and transactions than on in-state companies and transactions

• The Changing Economy• The service industry has replaced manufacturing as the driver of the US

economy.• An economy built on mobile capital and intangible property is subject to

much greater interstate competition than a manufacturing-based economy

• The Quest For Jobs• Similar to the search for the Holy Grail, government leaders are

enthusiastic about tax incentives because the political payoff – jobs – is immensely attractive.

• Unlike the patronage system, which contains inherent limits on the number of jobs a politician can create, a single incentive agreement can generate, or at least give the impression of generating, thousands of jobs.

NOT ALL COMPETITION IS EQUAL

• In the most general terms, healthy interstate competition involves using various methods, including tax policy, to develop an attractive mix of public services at a reasonable cost to taxpayers.• State competition in overall tax burdens,

however, can also have negative consequences because it often reduces the progressivity of state tax systems. • Interstate competition may place the greatest tax

burden on those firms and households perceived as least likely to leave the jurisdiction.

WHY STATES USE TARGETED TAX INCENTIVES

• States rely on targeted tax incentives, partly because political leaders often perceive that other types of interstate competition, such as low tax rates and good services, do not work quickly enough. Targeted tax incentives are an expedient way to create jobs. Public services (transportation and education systems, in particular) often require years to develop or improve.

• Interstate competition often results in a “quote arms-race” mentality.

• Tax policy, at least as far as targeted tax incentives are concerned, is often a matter of political expediency

POLICY ISSUES RAISED BY TARGETED TAX INCENTIVES

• Added Costs• Fairness• Added Administrative Inefficiency• Questions of Accountability.• Targeted Tax Incentives: A Sound Policy Choice?

STATE TAX, POLICY AND INTERSTATE COMPETITION

• Competition among the states is inevitable, especially as capital and labor become increasingly mobile.

• States essentially have two choices when it comes to interstate competition:• States can compete by providing high-quality public services

and imposing tax burdens consistent with those imposed by other states.

• States can compete by offering targeted tax incentives to particular businesses to entice them to relocate or to remain in the state.

• Because no state will unilaterally forgo tax incentives, this gives states two alternatives:• Cooperative agreements• Federal legislation