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Subsidies Grants and Abatements

By D. Eric Schansberg

A recent front-page article in the Courier-Journal illustrates the continuing interest in government offering subsidies to businesses at the state and local levels. Governor Daniels wants to tweak the award process of Indiana’s “21^st Century Research and Technology Fund”. Instead, he should end the program. Although the Fund is named for the 21^st century, the thinking behind it is more in line with 18^th century mercantilism and 20^th century central planning.

Local governments in Indiana often seek to subsidize specific manufacturing interests through targeted tax abatements. Meanwhile, the state government is trying to promote high-tech industries. The problem is the same in either case. Do the subsidies result in long-term net economic activity that outlives the corporate welfare and outperforms the alternate uses of that money in the private sector? And why would we imagine that the State has more knowledge than the Market in consistently picking winners in the business arena?

With these policies, there are four possible outcomes. First, the government can subsidize that which will be unsuccessful despite the subsidy. In this case, taxpayer money is thrown down a hole. Second, the government can subsidize that which will operate while receiving the subsidy but cease operations afterwards. In this case, taxpayer money is wasted since it is used to subsidize a short-term, inefficient project. Third, the government can subsidize that which would have been successful anyway. In this case, taxpayer money simply goes in the pocket of the business. Fourth, the government can subsidize that which could only start with the subsidy and continues to operate without subsidies afterwards. This is the only category that can be considered an economic success.

In practice, this is challenging to assess. Sufficient time is needed to determine whether the business endeavor will survive the length of the subsidy. Beyond that, it is difficult or impossible to determine when success was caused by the subsidy. But how many examples could there be in the fourth category? And what is the likelihood that the victories in that category outweigh the losses in the other three categories?

Proponents point to the economic activity generated by the grants and abatements—plus the ripple effects. But in each case, the results should be compared to what would have happened in the absence of the income transfer. For example, if taxpayers had $75 million more in their pockets, they would create $75 million worth of economic activity—plus the ripple effects of that money. As such, this mostly reduces to a shell game—where resources are shifted from taxpayers to connected business interests and where inefficiency is often subsidized by the general public.

That’s the economics of grants and tax abatements. What about the politics? Like most forms of income redistribution, these policies have concentrated benefits and small-per-person costs. So, it is easier to see the benefits and more difficult to see the costs. This means that policy makers are likely to overestimate the impact of such policies and likely to overstate the impact to their constituents. We can also count on recipients of the benefits to tell us how wonderful the program is! Meanwhile, the general public is unlikely to catch either error or deceit because the costs are so small per person. At the end of the day, this is largely about redistribution from average Hoosier taxpayers to the upper-class (those in universities and the “higher-paying jobs” the government is trying to attract), from the general public to the politically connected.

At the local level, most Democrats and Republicans support targeted tax abatements. And at the state level, most Democrats and Republicans support grants to targeted businesses. Democrats have more faith in the government as a central planner and Republicans are “pro-business”, so it’s a convenient marriage. In contrast, Libertarians are “pro-market”—a position frequently confused with pro-business, but more objective and ultimately friendlier to the general public as consumers and taxpayers.

It’s not particularly sexy and it isn’t as useful for winning elections, but a more equitable and efficient program for economic growth would focus on making the general environment for business as friendly as possible—for example, through lower taxes for all businesses. Instead, we have bureaucrats investing in what one observer called “highly speculative projects”. Why take the gamble? Similar to what they like to say about the lottery: someone’s got to lose, it might as well be the taxpayer.

D. Eric Schansberg

Professor of Economics

Indiana University (New Albany)

Adjunct Scholar: Indiana Policy Review and The Acton Institute

dschansb@ius.edu

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