State Development Incentives: Taxes, Investment, and Tullock Auctions
The North Carolina General Assembly is considering taking some of the current budget surplus and creating an “endowment,” a free-standing fund that be empowered to act as a government “angel” investor to encourage innovation in our state.
The Raleigh News and Observer story on the initiative—at least as of the morning of Monday, August 21—had a marvelous typo, an “Irish Bull”: “As House and Senate Republicans hash out a state budget, with passage destined for sometime after Sept. 1, the faith of an ambitious new nonprofit is at stake.” (emphasis added)
Faith, indeed. State innovation policies are excellent examples of faith-based spending, a faith arising from a thoughtless application of the worst kind of political opportunism. The author means “fate,” of course, but as with any Irish Bull the typo makes the statement much more insightful than it would have read as intended. This is faith-based public policy, except that the “faith” is “In bureaucrats we trust.”
The premise of the proposed expenditure—$1.5 billion, with a “b,” of taxpayer money is to be reserved as a permanent income-producing endowment the income from which is to be allocated by a 13-member board of special geniuses—is that North Carolina “lags behind” other states in innovation. Since NC does well on measures of research and development, there is a mystery: Where’s the innovation?
Two pieces of background are germane to this discussion. The first is the role of taxes, and government spending. The second is the role of private investment, and “skin in the game.” Let’s consider them in turn.
The Government Sector
Government finance is a residual category, since spending the state must, by definition (1) be taken from private hands in the form of taxes, (2) be accepted from private hands from the sale of debt, or (3) be stolen from private wealth in the form of inflation by profligate creation of new currency. That’s it, those are the only three sources of income for government: taxes, debt, and printing new money.
Any government spending of those funds, then, has hidden costs. To bureaucrats, all government spending is a benefit. But that’s just the “Broken Window Fallacy,” which looks only to the people or organizations who receive the “new” money, not to those from whom the wealth was taken. In this case, the budget “surplus” simply means that North Carolina is taking in far more money in taxes than it is spending on programs.
If NC uses the surplus to fund an endowment, the underlying assumptions are:
(a) the money could not be better spent on other state programs, and
(b) the money could not be better spent if it were returned to taxpayers, to be spent on what they want.
Now, I am not an anarchist. I am willing to concede, in principle and even as a matter of practice, that some state-run activities might result in very substantial benefits to taxpayers. It is the nature of public goods that the benefits exhibit huge economies of scale, but have such high fixed costs that no one individual is likely to undertake the initial expense. But the proposed endowment is a diversion of taxpayer funds to “invest” in private companies.
But the only “public” aspect of that activity is the (usually imaginary) spillover and multiplier effects of “create jobs” and “attract investment.” The claim that the government will spend our money “better” than we would spend it ourselves must rely either on an assumption that bureaucrats know more about each of us needs—which is nonsense, and violates a basic premise of liberalism—or that the government can solve collective action problems and provide public goods. Investment in private companies is not a public good.
The Private Investment Sector
Which brings me to the second point. The US has the best investment sector in the world, by quite a bit. In fact, as I argued three years ago in this space, “liquidity” is one of the three central foundational arguments for private capitalism. The process is faster and more accurate, and losses are paid for by those who stand to gain if the investment pays off.
Politics inverts that calculation: Nearly everything that private investors count as a “cost” goes on the “benefit” side of the ledger. Hire a bunch of construction workers to build a project out in the middle of nowhere, unconnected to infrastructure or markets? Clearly very costly, and a poor investment economically. But such “public projects” are a huge benefit to the politicians who are able to buy votes from those rural areas using the money of taxpayers from other parts of the state. If my rural district benefits, I get reelected, regardless of the fact that such pork barrel spending is a net waste of resources. (I’m looking at you, Global Trans Park, home of gigantic spending for rural “development” in North Carolina.)
How about “attract a business to a location that makes no economic sense”? A cost to the state, and to the nation, but a benefit to the local politicians who are able to divert public money to buy votes, and to enrich themselves with insider real estate deals. Look, the fact that private investment firms are not willing to make bets on these companies considering a move to rural areas means that such a move is more costly than the system of profit and loss would require. The extra costs to the company are being paid by taxpayers. The fact that private investors would not consider such risks tells us all we need to know: It’s a bad bet.
Unfortunately, the problems don’t end with (1) misuse of taxpayer money (2) to “invest” in projects that would not attract private investment support, though those two problems are significant. As I argued earlier this month, state “incentive” packages do more than pay companies the difference in costs. Politicians have every reason to pay up to, and beyond, the entire economic benefit to the state, because their calculus counts costs as benefits. “Extra” jobs, unneeded roads and utilities hookups, and large payments to politically connected consulting firms are all harms to taxpayers, but they help politicians get reelected.
The use of politically-motivated “incentives” as a means of attracting business to your state is a mook’s game. Taxpayers pay more than the company receives, because much of the cost comes from making unsuited areas “more competitive” for development. And more than all of the benefit that the state does receive from the new manufacturing jobs is spent by politicians using taxpayer funds to buy votes. It’s a “Tullock Auction,” and an example shows why it’s a bad idea.
Suppose a company wanted to auction off a $100 bill, and the bidders are state legislators. The “winner” gets to present the $100 bill to voters, with a big public ceremony and lots of news media fawning over the politician who brought home the Benjamin. How much would a legislator pay for such an opportunity to lock down votes?
It’s tempting to say that the bidding would quickly approach the full value of what is being “sold,” in this case, $100. But that’s wrong; there’s nothing to limit the bidding to that level. Remember, the “bids” are money taken from taxpayers, from the entire state. The legislator values the new project at $100, but her district is only going to pay a small fraction of that amount (North Carolina has 120 districts, so the benefit is $100 and the cost to one legislator is $100/120, or $0.83. Would you pay $0.83 to bring in $100? I would!) The legislator would be happy for the state to bid $200, or $500—even at $500 in costs, the cost share to one district is only $4.20!!—for the $100 benefit that goes primarily to her district.
There is simply no necessary connection between the total costs and the “benefits” being sought by politicians bidding with other people’s money. Far better to leave the money with taxpayers, who have other things to do with the resources, and depend on capital markets for investment, since for private ventures there must be some chance of producing net value.