Category Archives: Study of American Capitalism

The unseen costs of Amazon’s HQ2 Site Selection

Earlier this year Amazon narrowed down the list of potential cities to site its second headquarters. Applicants are now waiting out the selection process. It’s unclear when Amazon will make its choice, but that hasn’t stopped many from speculating who the likely contenders are. Varying sources report Atlanta, Boston, and Washington D.C. at the top of the list. The cities that didn’t make the cut are no doubt envious of the finalists, having just missed out on the potential for a $5 billion facility and 50,000 jobs. The second HQ is supposed to be as significant for economic growth as the company’s first site, which according to Amazon’s calculations contributed an additional $38 billion to Seattle’s economy between 2010 and 2016. There is clearly a lot to be gained by the winner.  But there are also many costs. Whichever city ends up winning the bid will be changed forever. What’s left out of the discussion is how the bidding process and corporate incentives affect the country.

Although the details of the proposals are not made public, each finalist is likely offering some combination of tax breaks, subsidies, and other incentives in return for the company’s choice to locate in their city. The very bidding process necessitates a lot of time and effort by many parties. It will certainly seem “worth it” to the winning party, but the losers aren’t getting back the time and effort they spent.

This practice of offering incentives for businesses has been employed by states and localities for decades, with increased usage over time. Targeted economic development incentives can take the form of tax exemptions, abatements, regulatory relief, and taxpayer assistance. They are but one explicit cost paid by states and cities looking to secure business, and there is a growing literature that suggests these policies are more costly than meets the eye.

First, there’s the issue of economic freedom. Recent Mercatus research suggests that there may be a tradeoff to offering economic development incentives like the ones that Amazon is receiving. Economists John Dove and Daniel Sutter find that states that spend more on targeted development incentives as a percentage of gross state product also have less overall economic freedom. The theoretical reasoning behind this is not very clear, but Dove and Sutter propose that it could be because state governments that use more subsidies or tax breaks to attract businesses will also spend more or raise taxes for everyone else in their state, resulting in less equitable treatment of their citizens and reducing overall economic freedom.

The authors define an area as having more economic freedom if it has lower levels of government spending, taxation, and labor market restrictions. They use the Fraser Institute’s Economic Freedom of North America Index (EFNA) to measure this. Of the three areas within the EFNA index, labor market freedom is the most affected by targeted economic development incentives. This means that labor market regulation such as the minimum wage, government employment, and union density are all significantly related to the use of targeted incentives.

Economic freedom can be ambiguous, however, and it’s sometimes hard to really grasp its impact on our lives. It sounds nice in theory, but because of its vagueness, it may not seem as appealing as a tangible economic development incentive package and the corresponding business attached to it. Economic freedom is associated with a series of other, more tangible benefits, including higher levels of income and faster economic growth. There’s also evidence that greater economic freedom is associated with urban development.

Not only is the practice of offering targeted incentives associated with lower economic freedom, but it is also indicative of other issues. Economists Peter Calcagno and Frank Hefner have found that states with budget issues, high tax and regulatory burdens, and poorly trained labor forces are also more likely to offer targeted incentives as a way to offset costly economic conditions. Or, in other words, targeted development incentives can be – and often are – used to compensate for a less than ideal business climate. Rather than reform preexisting fiscal or regulatory issues within a state, the status quo and the use of targeted incentives is the more politically feasible option.

Perhaps the most concerning aspect of Amazon’s bidding process is the effect it has on our culture. Ideally, economic development policy should be determined by healthy economic competition between states. In practice, it has evolved into more of an unhealthy interaction between private interests and political favor. Economists Joshua Jansa and Virginia Gray refer to this as cultural capture. They find increases in business political contributions to be positively correlated with state subsidy spending. Additionally, they express concern over the types of firms that these subsidies attract. There is a selection bias for targeted incentives to systematically favor “flighty firms” or firms that will simply relocate if better subsidies are offered by another state, or potentially threaten to leave in an effort to extract more subsidies.

None of these concerns even address the question of whether targeted incentives actually achieve their intended goals.  The evidence does not look good. In a review of the literature by my colleague Matthew Mitchell, and me, we found that of the studies that evaluate the effect of targeted incentives on the broader economy, only one study found a positive effect, whereas four studies found unanimously negative effects. Thirteen studies (half of the sample) found no statistically significant effect, and the remaining papers found mixed results in which some companies or industries won, but at the expense of others.

In addition to these unseen costs on the economy, some critics are beginning to question whether being chosen by Amazon is even worth it. Amazon’s first headquarters has been considered a catalyst for the city’s tech industry, but local government and business leaders have raised concerns about other possibly related issues such as gentrification, rising housing prices, and persistent construction and traffic congestion. There is less research on this, but it is worth considering.

It is up to each city’s policymakers to decide whether these trade-offs are worth it. I would argue, however, that much of the evidence points to targeted incentives – like the ones that cities are using to attract Amazon’s business – as having more costs than benefits. Targeted economic development incentives may seem to offer a lot of tangible benefits, but their unseen costs should not be overlooked. From the perspective of how they benefit each state’s economy as a whole, targeted incentives are detrimental to economic freedom as well as our culture surrounding corporate handouts. Last but not least, they may often be an attempt to cover up other issues that are unattractive to businesses.

Why regulations that require cabs to be painted the same color are counterproductive

A few weeks ago, my colleagues Chris Koopman, Adam Thierer and I filed a comment with the FTC on the sharing economy. The comment coincided with a workshop that the FTC held at which Adam was invited to speak. Our comment, our earlier paper (forthcoming in the Pepperdine Journal of Business Entrepreneurship and the Law), and a superb piece that Adam and Chris wrote with MA fellows Anne Hobson and Chris Kuiper, have been getting a fair amount of press attention, most of it positive.

I want to highlight one piece that seems to have misunderstood us. I highlight it not because I blame the author, but because I assume we must not have described our point well. Paul Goddin of MobilityLab writes:

Their argument seems valid, but an example they use is New York City’s rule that taxicabs be painted the same color. They argue this regulation is a barrier to entry, yet neglect to mention that Uber also requires its drivers to adhere with automobile standards (although these standards have been loosened recently). As of this article, Uber’s drivers must possess a late-model 2005 sedan (2000 in some cities, 2007-08 in others), with specific color and make restrictions for those who operate the company’s Black car service.

A rule that requires everyone in an industry to use the exact same equipment, branding and paint color is, I suppose, a barrier to entry. But that isn’t why we raised the issue. We raise it because—more importantly—it is a barrier to signaling quality.

It is a good thing that Uber and Lyft require their drivers to adhere to standards, just as it is a good thing that TGI Fridays and CocaCola set their own standards. Walk into a TGI Fridays anywhere in the world and you will encounter a familiar experience. That is because the company sets standards for its recipes, its decorations, its employee’s behavior, its uniforms, and much else. Similarly strict standards govern the way CocaCola is packaged, and marketed. Retailers that operate soda fountains are all supposed to combine the syrup and the carbonated water in the same way. If they don’t, they may find that CocaCola no longer wants to work with them.

These practices ensure quality. And they help overcome what would otherwise be a significant information asymmetry between the buyer and the seller. But notice that these signals only work because they are tied to the brands. Imagine what would happen if Chili’s, Outback Steakhouse, and Macaroni Grill were all required by law to adopt the same logos, the same decor, the same recipes, and the same uniforms as TGI Fridays. Customers would have no way of distinguishing between the brands, and therefore the companies would have little incentive to provide quality service in order to protect their reputations. Who cares about cooking a T Bone properly if the other guys are likely to get blamed for it?

So here in lies the problem with taxi regulations that require all cabs to offer the same sort of service, right down to the color of their cars: If every cab looks the same, no one cab company has an incentive to carefully guard its reputation.

An interesting development in state regulation of wine shipment

Can one state enforce another state’s laws that prohibit direct-to-consumer wine shipment from out-of-state retailers while allowing it by in-state retailers?  That’s the question posed in a recent New York case.

The New York State Liquor Authority has a rule that prohibits licensees from engaging in “improper conduct.”  The liquor regulator argues that direct shipments by retailers that violate other states’ laws constitute improper conduct.  It has fined, revoked licenses, and filed charges against New York retailers that it believes have shipped wine illegally to customers in other states. One retailer, Empire Wine, refused to settle and has sued the liquor authority in state court, claiming that the “improper conduct” rule is unconstitutionally vague and that the liquor authority cannot enforce other states’ laws that discriminate against interstate commerce.

Many states continue to prohibit direct shipment from out-of-state retailers. For example, 40 states do not allow New York retailers to ship directly to consumers.  This harms consumers, because it is usually out-of state-retailers, rather than wineries, that offer significant savings compared to in-state retailers. In a 2013 article published in the Journal of Empirical Legal Studies, Alan Wiseman and I identified two different anti-consumer effects of laws that allow out-of-state wineries to ship direct to consumer but prohibit out-of-state retailers from doing so. First, these laws deprive consumers of price savings from buying many bottles online: “Online retailers consistently offered price savings on much higher percentages of the bottles in each year—between 57 and 81 percent of the bottles when shipped via ground and between 32 and 48 percent when shipped via air. Excluding retailers from direct shipment thus substantially reduces—but does not completely eliminate—the price savings available from purchasing wine online.” Second, these laws reduce competitive pressure on bricks-and-mortar wine stores, since they exclude lower-priced out-of-state retailers from the local market. Thus, the laws likely harm consumers who buy from their local wine shops, not just consumers who want to buy online. (The published version of the paper is behind a paywall, but you can read the working paper version at SSRN.)

(Photo credit: http://srxawordonhealth.com/2011/07/11/exercise-in-a-bottle/)

 

FDR’s Failed Thanksgiving Experiment: Benefiting Big Business, Dividing a Country

Nothing is free from the threat of political favoritism.  Not even the holidays.  And, as it turns out, Thanksgiving actually fell prey to it for a few years under Franklin Delano Roosevelt.

But first, a bit of Thanksgiving History.  At the request of the first Federal Congress, President Washington issued a proclamation naming Thursday, November 26, 1789 as a “Day of Publick Thanksgivin [sic].”  Subsequent presidents followed Washington by issuing their own Thanksgiving Proclamations.  However, the dates and months of the proclamations varied.  Eventually, under Abraham Lincoln, Thanksgiving was set to be regularly commemorated each year on the last Thursday of November. Franklin and Eleanor (FDR Bio, part 1)

In 1939, the last Thursday in November fell on the last day of the month.  As a result, President Franklin D. Roosevelt issued a Presidential Proclamation moving Thanksgiving to the second to last Thursday of November.

Why did Roosevelt see the need to move Thanksgiving?

The Huffington Post’s Sam Stein and Arthur Delaney explain that “Roosevelt was responding to pressure from retail lobbyists who worried that Christmas shopping would lag because Thanksgiving was set to fall particularly late that year, on Nov. 30.”

In fact, Stein and Delaney note:

Lew Hahn, general manager of the Retail Dry Goods Association, sent a message to Secretary of Commerce Harry Hopkins that although he didn’t dare bring this to the president’s attention, a late Thanksgiving might have a ‘possible adverse effect on the production and distribution of holiday goods.’

Hopkins told Roosevelt anyway, and the president, sensitive to the needs of business, moved the date of the holiday.

However, not everyone was interested in moving the holiday for the benefit of big retailers.  Small businesses wrote to the President, explaining:

[W]e have waited years for a late Thanksgiving to give us an advantage over the large stores, and we are sadly disappointed at your action, in this matter.  Kindly reconsider and oblige thousands of small retail storekeepers throughout this country.

Ultimately, 32 states issued proclamations moving Thanksgiving to the second to last Thursday, while 16 states refused to change and proclaimed Thanksgiving to be the last Thursday in November.   For two years, the United States had two Thanksgivings.  The President and part of the country celebrated it on the second to last Thursday in November.  The rest of the country celebrated it a week later.

After two years, and four Thanksgivings, Congress put an end to the confusion by setting a fixed date for the holiday.  In 1941, the House of Representatives passed a resolution declaring “the last” Thursday of November to be Thanksgiving Day.  The Senate amended the resolution to read that it be celebrated on “the fourth” Thursday, to take into account those years when there are five Thursdays in November.  On December 26, 1941, Roosevelt signed the resolution, thereby establishing the modern Thanksgiving Holiday.

Did Roosevelt’s “Franksgiving” experiment work?  Not exactly.  Stein and Delaney write that the Commerce Department found that expected expansion of retail sales never occurred.  In the end, they note, Roosevelt conceded that the economic benefits of moving Thanksgiving had not been worth the struggle.

Enjoy your Thanksgiving turkey.  Just think, at one you time, you could’ve done it twice.

Richmond, Calif., Eminent Domain, and the Problems of Political Privilege

Sign Of The Times - ForeclosureRichmond, California is now moving forward with a proposal to use eminent domain to acquire more than 600 “underwater mortgages” (mortgages with unpaid balances greater their properties’ market value).

Eminent domain has long been used by governments for various public uses, such as highways, roads, and public utilities.  More recently this has been extended to include shopping mallsbusiness parks, and professional sports stadiums. However, while contemplated by other cities, eminent domain has never been used for the purpose of seizing mortgages. Richmond would be the first city to actually carry out such a plan.

On its face, the plan is straightforward. The city has offered to buy these underwater mortgages at discounted rates from the banks and investors currently holding these mortgages. If the offers are rejected, the city will use eminent domain to force the sale of these mortgages to the city. The city will then write down the debt, refinancing the loans for amounts much more in line with current home values.

While the stated objective of this plan is to provide mortgage relief to homeowners hurt by the most recent housing crises, the plan is rife with opportunities for political privilege and favoritism.  Ilya Somin, a law professor at the George Mason University School of Law, has laid out several problems involved with this scheme:

  • Far from benefiting low-income people as intended, the plan will actually harm them. Much of the money to condemn the mortgages and pay litigation expenses will come from taxpayers, including the poor. Most of the poor are renters, not homeowners, so they cannot benefit from this program. But renters do indirectly pay property taxes through the property taxes paid by their landlords, a cost which is built into their rent.
  • The program would also enrich those who took dangerous risks at the expense of the prudent. It isn’t good policy to force more prudent taxpayers to subsidize the behavior of people who took the risk of purchasing high-priced real estate in the midst of a bubble. Doing so will predictably encourage dubious risk-taking in the future.
  • Prudent Richmonders will also lose out from this policy in another way. If lenders believe that the city is likely to condemn mortgages whenever real estate prices fall significantly, they will either be unwilling to lend to future home purchasers in Richmond, or only do so at higher interest rates. That will hurt the local economy and make it more difficult for Richmonders to buy homes.
  • We should also remember that eminent domain that transfers property to private parties is often used to benefit the politically powerful at the expense of the poor and the weak. In Kelo v. City New London (2005), a closely divided Supreme Court ruled that government could take private property and transfer it to influential business interests in order to promote “economic development.” As a result, multiple New London residents lost their homes for a “development” project that still hasn’t built anything on their former property eight years later. Property owners lost their rights and the public has yet to see much benefit. The Richmond policy would create another precedent to help legitimate future Kelos.

You can read Somin’s article here.

It should be noted that there is a legal challenge underway as banks and investors argue that the city’s plan is unconstitutional. However, regardless of the plan’s legality, it is clear that it will do little to support economic development, aid the housing market, or support future investment in the local economy. It seems more about using these mortgages to privilege the few at the expense of the many.

U.S. Income Inequality vs. World Income Inequality

A few weeks ago, Matt Yglesias had this to say on Twitter:

Yglesias quote

 

 

 

 

He was referring to this chart, taken from Branko Milanovic’s excellent 2010 book The Haves and the Have-Nots. As informative as the chart is, I—like Matt Y—have always found it a bit inaccessible. So I decided to remake it in video form, enlisting the help of the creative and ever-patient Charles Blatz. Let us know what you think:

Are you ready for some (subsidized) football?

This weekend marks the start of the NFL season, and with it comes the fanfare and attention that being the most lucrative professional sport in America has come to demand.  However, this success has fueled the lucrative stadium financing deals that have been secured by these teams over the past 20 years, often at the expense of taxpayers.

Olympic Stadium London - Anniversary (Blended)Take, for example, the stadium deal given to the Cincinnati Bengals by Hamilton County in Ohio. Still the most lucrative subsidy in the history of professional football, taxpayers were left paying 94 percent of the $449.8 million tab. This amount doesn’t include other costs in the generous lease, such as the agreement by the county to cover all of the costs of operation and capital improvements. The lease also leaves taxpayers on the hook to fund projects that have not even been invented yet, such things as “ticketless entry systems,” “stadium self-cleaning machines,” and even “holographic replay machines.”

The Cincinnati Bengals are certainly not alone in getting these sorts of publicly-funded gifts. The Buffalo Bills recently obtained $95 million in subsidies for stadium upgrades.  In return, the state of New York will be given a luxury suite to promote the sorts of corporate handouts that the state can give to other businesses.  Meanwhile, the Atlanta Falcons will receive $200 million from the city of Atlanta toward a new stadium, funded through bonds backed by the city’s hotel-motel tax.  The Kansas City Chiefs and the Carolina Panthers have also recently received generous taxpayer-funded stadium deals.  The list goes on.  Nearly every NFL stadium built since 1997 has received some public funding.

And what do these deals really do to promote economic development?  Almost nothing.  According to economists Robert Baade and Victor Matheson, researchers looking into the economic impact of new sports facilities “have almost invariably found little or no economic benefits.”  This should come as no surprise to economists and policymakers.  Dennis Coates and Brad Humphreys have surveyed the literature and found “a great deal of consistency among economists doing research in this area. That . . . sports subsidies cannot be justified on the grounds of local economic development, income growth or job creation.”

Why, then, do politicians continue to hand out these privileges at the taxpayers’ expense? One answer is that these sports teams are well-connected and well-organized, giving them an inherent lobbying advantage over a multitude of unorganized taxpayers.  For example, the owner of the Miami Dolphins has created an active political group to attack lawmakers he blames for a failed measure to provide taxpayer support for a $350 million upgrade to Sun Life Stadium.

Another possible explanation is that people love their hometown teams, and most politicians are eager to associate themselves with anything that appears popular.  Even if that means giving these teams handouts at the taxpayers’ expense.

So as the football season begins and continues to play out over the next 6 months, you ought to take some time to enjoy your hometown team.  Odds are, you are already paying for it.

The Public Choice of Sustainable Tax Reform

Comprehensive tax reform has gotten a jump-start from Senators Max Baucus (D-MT) and Orrin Hatch (R-UT), the chairman and ranking Republican on the Senate Finance Committee.  The Senate’s two top tax writers announced a new “blank slate” approach to tax reform in a “Dear Colleague” letter issued last week.

The Senators describe their new, blank slate approach as follows:

In order to make sure that we end up with a simpler, more efficient and fairer tax code, we believe it is important to start with a “blank slate”—that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences…

However, under their framework, every current tax privilege has a chance to survive.  The Senators explain:

We plan to operate from an assumption that all special provisions are out unless there is clear evidence that they: (1) help grow the economy, (2) make the tax code fairer, or (3) effectively promote other important policy objectives.

This plan has drawn both praise and criticism, and rightly so.  Yes, this is a step in the right direction; however, this is unlikely to lead to any sustainable reforms for two reasons.

First, forcing Congress to defend tax privileges won’t be hard.  To become law, each privilege had a sponsor, and each sponsor had a rationale to defend it.  Each tax privilege was passed by Congress, and each was then signed into law.  It is difficult to see how privileges that have already survived this process won’t once again find a congressman willing to defend them.  So long as Congress has the power to create and protect tax privileges, it will be nearly impossible to simply wipe such privileges away.

Second, even if a blank slate were achieved, it is unlikely that a privilege-free tax code would last long under the current institutional framework.  This is best demonstrated by what happened in the aftermath of the Tax Reform Act of 1986 (TRA86).

James Buchanan, writing after the passage of TRA86, predicted that very little its reforms would remain intact.  Buchanan noted that “[t]o the extent that [political] agents do possess discretionary authority, the tax structure established in 1986 will not be left substantially in place for decades or even years.”

Buchanan was spot on.  From 1986 through 2005, the tax reform of 1986 suffered a death of 15,000 tweaks.  As reported by the President’s Advisory Panel on Federal Tax Reform in 2005, in the two decades after the 1986 tax reform bill was passed, nearly 15,000 changes were made to the tax code – equal to more than two changes per day for 19 years straight.

What insight did Buchanan have that allowed him to so aptly predict the demise of the Tax Reform Act of 1986?  Buchanan understood that institutions matter.  That is, he understood that no matter how many times the tax code was reformed, so long as the same institutions remain unchanged, political actors will continue to respond in predictable ways, and the result would be tax privileges creeping their way back into the code.  Buchanan explained:

The 1986 broadening of the tax base by closing several established loopholes and shelters offers potential rents to those agents who can promise to renegotiate the package, piecemeal, in subsequent rounds of the tax game. The special interest lobbyists, whose clients suffered capital value losses in the 1986 exercise, may find their personal opportunities widened after 1986, as legislators seek out personal and private rents by offering to narrow the tax base again. In one fell swoop, the political agents may have created for themselves the potential for substantially increased rents. This rent-seeking hypothesis will clearly be tested by the fiscal politics of the post-1986 years.

Going forward, if any sort of reforms are achieved in the tax code, this rent-seeking hypothesis will be tested again.

Senators Baucus and Hatch admit that a blank state “is not, of course, the end product, nor the end of the discussion.”  If Buchanan’s predictions remain true today, as they most certainly are, then the Senators are quite right in admitting that a blank slate is not, and will never be, an end product.  That is, of course, unless any reform in the tax code is paired with institutional reforms to ensure that special tax privileges do not creep back into the code.

The Study of American Capitalism

(Note to readers: Three talks in three states over the last week have made me a terrible blogger. Thankfully, Eileen and Emily have stepped up where I have stepped down.)

Mercatus has now organized its work around government-granted privilege and crony capitalism under a new project called the Study of American Capitalism. We are thrilled that Celia Sandel has joined the Mercatus team to manage the project. If you are a scholar working or thinking about working in this field, please reach out to Celia. We’d love to hear from you.

Speaking of which, we’ve already released a number of excellent papers on the topic. And now, in no particular order:

In Crony Capitalism: By-Product of Big Government, Professor Randal Holcombe of Florida State University explores the links between government power and cronyism, writing:

The more government is involved in an economy, the more the profitability of business will depend on government policy. Even those entrepreneurs who would prefer to avoid cronyism are pushed into it, because they must become politically active to maintain their profitability. When the government looms large in economic affairs, businesses push for government policies that can help them, and try to avoid suffering harm as a result of government policies that can work against them. If one’s competitors are engaging in cronyism, avoiding cronyism means that one’s competitors will gain government-bestowed advantages.

In Government Cronyism and the Erosion of Public Trust, Professor John Garen of the University of Kentucky examines the relationship between cronyism and eroding trust in government. He writes:

Survey data show a large decline in trust in government, much of which has occurred while government grew rapidly. Evidence indicates that government growth has been associated with rent-seeking and cronyism, leading to a withdrawal of trust. Thus, cronyism—bad government— can undermine even the appropriate functions of government.

Professors Daniel Smith and Daniel Sutter of Troy University gauge public perceptions of the problem in Gauging the Perception of Cronyism in the US:

Cronyism can have real and significant costs, yet it is challenging to measure objectively. In fact, just the perception of cronyism can inhibit business formation, distort the allocation of entrepreneurial talent, and undermine support for free market capitalism. Refined measures of perceptions of cronyism among both business leaders and the public could help advance our understanding of cronyism and its effects on our economic system.

Last, but by no means least, my graduate-school colleague Professor Jeremy Horpedahl of Buena Vista University has teamed up with my current student, Brandon Pizzola, to explore the privileges that lurk in our tax code in A Trillion Little Subsidies:

Total tax expenditures in the United States are currently around $1 trillion, with over 80 percent accruing to individuals and the remainder to corporations. We review each of the ten largest tax expenditures for individuals and corporations, focusing on the following distortions of economic activity: spending on goods and services, capital allocation, the distribution of income, and lobbying and rent-seeking. The benefits of tax expenditures accrue disproportionately to higher-income earners, since they are more likely to itemize deductions and can afford to hire accountants to minimize their tax burden. Eliminating tax expenditures would increase economic growth and allow for lower tax rates, further increasing growth.

(Many) more to come!