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You tell me it’s the institution…

by Matt Mitchell on May 16, 2013

in Government-Granted Privilege

When scandals erupt, the human tendency is to look for some nefarious person wearing a black hat and blame them. However psychologically satisfying this may be, it is not particularly helpful. It offers no constructive solution to avoid future problems, other than to be “ever-vigilant” against bad behavior.

In contrast, law professor Victor Fleischer’s take on the unfolding IRS scandal is a nice example of a more-useful reaction, one that focuses on the institutional factors that made the scandal likely to happen in the first place:

The root of the problem is poor institutional design, not a political conspiracy. Current law forces the I.R.S. to enforce a vague set of campaign finance laws that have next to nothing to do with raising revenue.

It is constructive to apply Fleischer’s approach to another unfolding scandal. In the past few weeks, the press has reported that the FBI is investigating Virginia Governor McDonnell for his ties to a major donor, Jonnie Williams. Williams, described by McDonnell as a close family friend, paid for the food at McDonnell’s daughter’s wedding reception and loaned the first family his fancy sports car for a day. In the last few years, the governor and the first lady seem to have given Williams’s company, Star Scientific, free promotion. For example, in August of 2011, McDonnell appeared at an event promoting Star Scientific at the Executive Mansion. And in June of 2011, the first lady flew to Florida to tout the company’s product, a dietary supplement.

The inquiry apparently began out of concern for the possibility of a quid pro quo: perhaps the governor and the first lady offered this free promotion in exchange for political and personal favors? For their part, the governor and first lady have maintained that it is their job is to promote Virginia businesses.

Indeed, the state legislature seems to think this is part of the governor’s job. Over the years, legislators have given the governor a host of tools to offer exclusive privileges to particular businesses. For example, the Governor’s Opportunity Fund “is a discretionary incentive available to the Governor to secure a business location or expansion project for Virginia.” There’s also the Governor’s Agriculture and Forestry Industries Development Fund. This too gives grants “at the discretion of the Governor.” You can read about these and other programs at the “business incentives” section of the Virginia Economic Partnership website. There, you will see that privileges include subsidies, matching grants, in-kind donations such as training, corporate and individual income tax credits, sales and use tax exemptions, property tax exemptions, and various financing programs. (In the case of Star Scientific, the governor seems not to have availed himself of any of these programs. Instead, he and his wife seem to have simply talked favorably about the company, just as they frequently talk favorably about other Virginia businesses.)

Presumably legislatures give governors the authority to grant special favors to firms because they believe these favors benefit the state. But the evidence that targeted incentives lead to any sort of widespread prosperity is quite scant. And as my research has emphasized, privileges lead to a host of economic problems because they undermine competition, encourage wasteful privilege-seeking, and put politicians rather than consumers in charge of allocating capital and resources.

But the Virginia story illustrates another cost of privilege: it inevitably invites questions of impropriety. The fact is, it is very difficult to devise objective criteria for dispensing privileges to particular firms. So one doesn’t have to look very hard to find apparently subjective decisions: Was Solyndra awarded half a billion taxpayer dollars because it had a superior business model? Or was it given money because green energy is politically popular and the vice president wanted to host a ribbon-cutting ceremony there? Did the Administration offer trade protection to domestic solar panel makers because the Chinese were engaged in “unfair competition” or because domestic solar panel manufacturers are politically powerful and well-connected?

I don’t see how these questions could possibly be answered definitively. Instead of trying to pretend that they can be, we should change the institutions that inevitably give rise to charges of impropriety. We should stop presuming that an elected official’s job description includes the promotion of particular businesses. If we stop asking politicians to pick winners and losers, there will be no more scandals about whom they pick.

Full disclosure: A few years ago, Governor McDonnell appointed me to serve on Virginia’s Joint Advisory Board of Economists. Once a year I travel to Richmond and offer my opinion on the state’s economic and fiscal forecasts. I am not compensated for my participation.

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