Given the economic development and job creation justification for most corporate welfare schemes, it would be natural to wonder, What is so bad about it? After all, most people would agree that job creation through job training and investment is a good thing. The fundamental issue, though, is whether corporate welfare results in efficient market outcomes in terms of jobs and investments, based on the actual resource costs and productive benefits. For example, the federal government heavily subsidizes the ethanol industry, but this has led to heavy water use to grow corn for ethanol production instead of for food and animal feed. This has, in turn, led to higher food costs than would have existed otherwise. Likewise, state and local subsidies distort economic outcomes leading to inefficiencies that, in total, can be quite significant.
Because corporate welfare programs, whether in the form of grants, loans, or favorable tax treatment, are determined by political forces to advantage certain types of businesses or economic activity, distortions are created in the marketplace by favoring one type of capital category or business model over another. The success of such a strategy is severely limited by government’s inability to make the best use of knowledge about the potential future winners in the marketplace. Some industries, such as solar and wind power generation, Hollywood productions and professional sports, have received a good deal of favorable attention from government. Yet, there is no certainty that these investments will ultimately become cost effective. If they never do, government will have encouraged endeavors that demonstrably result in more costs than benefits, and therefore are a waste of finite investment resources.
Empirical studies produced by professional economists indicate that government isn’t better than the market at either picking winners in the marketplace or at encouraging job growth. For example, a recent study looked at the Kansas tax credit program Promoting Employment Across Kansas, or PEAK. The study took a unique approach to determining the effectiveness of the program by surveying the natural experiment taking place in that state. It compared companies with similar attributes except for one: whether they received a PEAK job creation tax credit or not. Nathan Jensen of the University of Texas-Austin, the author of the study, concluded that companies that received PEAK tax credits were not statistically any more likely to create new jobs than similar firms that did not receive the subsidy. Additionally, the PEAK recipient companies had little impact on job creation in the state because they were simply no more dynamic in the creation of new jobs compared to the nonsubsidized control group.
This is consistent with the weight of empirical analysis on this subject. A comprehensive 2004 article in the Journal of the American Planning Association by Alan Peters and Peter Fisher of the University of Iowa comes to a conclusion that has since largely become the consensus among academic economists. After reviewing a wide body of articles and cost-benefit analyses on economic development programs — which included multiple tax credit programs and enterprise zones — they conclude that “there are very good reasons — theoretical, empirical, and practical — to believe that economic development incentives have little or no impact on firm location and investment decisions.”
Peters and Fisher go further to state what likely drives support for these programs. They suggest:
The most fundamental problem is that many public officials appear to believe that they can influence the course of their state and local economies through incentives and subsidies to a degree far beyond anything supported by even the most optimistic evidence. We need to begin by lowering [policymakers'] expectations about their ability to micromanage economic growth and making the case for a more sensible view of the role of government — providing the foundations for growth through sound fiscal practices, quality public infrastructure, and good education systems — and then letting the economy take care of itself.
An almost tragic example of how corporate welfare can backfire comes out of Arizona. In 2008, the state Legislature passed a measure creating an amusement park district that would have essentially zeroed out sales taxes for an amusement park constructed under that law. Ostensibly, the law was passed for a rock-and-roll themed amusement park proposed for an area near Eloy. Within a year of the measure’s passage, the entity supposedly developing the park had gone bankrupt.
In the meantime, long-time Arizona resident and independent businessman Dan Stokich, prior to the amusement park district law’s passage, was on the cusp of assembling the financial investors necessary to build a large amusement park on a Disney-like scale. Because his marketing consultants’ studies indicated Eloy was unsuitable for such a project, he would never have taken advantage of the amusement park district law. At the same time, despite the unlikelihood of the rock-n-roll themed park's success, the Arizona Legislature’s action introduced enough additional risk for Stokich’s investors that they backed out altogether. To this day, Arizona has no major amusement park, and there is evidence that the Eloy proposal and a more recent one that materialized after the Eloy law’s expiration only existed as distractions to block legitimate efforts like Stokich’s.[*]
Other examples of crony economic development schemes that have backfired just from Arizona include speculative deals involving the issuance of bonds to attract private enterprises to specific locations. The cities of Gilbert and Peoria have issued bonds to support construction for the benefit of private colleges, only to see what they thought were promising enterprises ultimately shuttered. Pima County issued bonds for the sake of a high-altitude, balloon-making company that is unlikely to ever have more than a handful of employees.
Corporate welfare also distorts healthy private capital markets because it makes the targets of the subsidy more attractive to investors than they would be otherwise. Investors in the subsidy-receiving companies would anticipate a higher rate of return or less risk than they might otherwise since costs are effectively reduced by the subsidy. Consequently, more investment flows to the companies that take advantage of corporate welfare opportunities. This might be appropriate if government officials possess a clearer vision of how such investments will fare in markets, but there is no reason to believe this is the case. In fact, it is far more likely that government officials substituting their limited judgment for the market’s collective judgment will result in a less than optimal outcome with too much investment in government’s arbitrarily favored industries.
Corporate welfare also encourages economic waste while simultaneously encouraging corruption or its close cousin, cronyism. Businesses and industries expend resources vying for various types of subsidies — which by definition are economically inefficient as these are resources that could otherwise be used to invest in more productive ventures. Others who are their competitors might expend resources in an effort to fight against prospective subsidies, which furthers — indeed potentially doubles — the economic waste of resources dedicated to lobbying efforts.
Elected and appointed officials get courted by interests seeking profit by any means and can often be misled about the efficacy of their decisions. This creates an environment fertile for outright corruption such as bribery, or the softer corruption of susceptibility to suggestion from lobbyist friends who have carefully cultivated relationships with policymakers. And it also creates opportunities to exchange favors to select interests for employment opportunities for outgoing legislators and their friends. In any case, the more favors government officials can hand out to select interests, the higher the stakes for these interests to command a politician’s favor.[†]
Finally, businesses and industries that receive corporate welfare take greater risks than they might otherwise because risk is more affordable and is usually imprudent relative to market realities. A sizable portion of solar companies that have been subsidized at multiple levels of government have gone bankrupt. This could be partly due to risks being taken that otherwise would not have been taken had corporate welfare subsidies not been handed out. These are wasted scare resources that should have been put to more efficient use.
[*] Only after author (Schlomach) wrote of the foolishness of the amusement park district’s creation was he contacted by Stokich, who was armed with artwork and consulting studies, making clear the legitimacy of his efforts. Articles written by Schlomach at the time for the Goldwater Institute are, unfortunately, no longer available online.
[†] A description of the political dynamics of corruption birthed from cronyism is discussed in Matthew D. Mitchell, “The Pathology of Privilege: The Economic Consequences of Government Favoritism” (Mercatus Center at George Mason University, July 9, 2012), https://perma.cc/TF3Z-5LYW.