Local Governments on Safari for Big Game

by Geoffrey Anderson

Metropolitan areas have expanded dramatically in the last fifty years, reaching out into undeveloped farmlands and rural areas like no other time in U.S. history. Geographic expansion has usually also meant increased numbers of local governments--in some cases substantial increases. Kansas City has no fewer than 468 local governments. Chicago boasts 1,467. This highly fragmented system of governance can be very responsive to local demands, but it can also lead to inefficiency and lack of regional coordination. A case in pointis the competition for economic development among local jurisdictions.

In any given metropolitan region, local governments actively compete with each other to attract businesses and other "big game" tax base. Recently this competition has become more prevalent and intense. Yet there is compelling evidence that these fights for local fiscal stability are causing fiscal harm. Localities often make deals that fail to generate the expected benefits. Officials forgo revenue by bidding down their tax rates against other jurisdictions. The immediate losers are often the local jurisdictions themselves and smaller tax payers. But competition for tax base is of broader concern. Fiscal crises at the local level jeopardize service provision-- services like education, environmental protection, and other basic services--affecting not just local residents, but also hindering achievement of our national goals.

Local Competition for Tax Base

While notable examples of regional cooperation for economic development exist -- Portland Oregon, Minneapolis/St. Paul, Minnesota, and others--competition among jurisdictions is the norm. Competition for tax base has been intensified by dwindling federal funds, devolution of services to the local level, and local opposition to new taxes. Jurisdictions are not just competing for new businesses, they also compete to retain businesses. In their efforts to "build their tax bases," local governments have become increasingly innovative in the way they provide subsidies. Whereas tax breaks used to dominate, local governments now also provide job training funds, issue government backed bonds, and provide low-interest financing.

When businesses move to take advantage of lower land prices or rents, generally the move does deliver some efficiency gains within the economy. But when a company's decision to move is influenced by subsidies, and the common phenomenon of "going shopping" for subsidies, it's not clear that true economic efficiency is gained. Sometimes the subsidies entice businesses out of urban areas into suburban and undeveloped areas. These moves accelerate sprawl and increase pressure on services in urban areas with laid off employees and decreasing tax revenues.

Brooks Sausage, a minority-owned and largely minority- employee firm located in Chicago, was offered significant incentives to relocate its facility to a smaller city in Wisconsin. It moved and laid off its Chicago work force. While the Wisconsin town gained employment, it may be in for some surprises. There are numerous examples where jurisdictions offering lavish subsidies were burned. The subsidies never pay for themselves in some cases because companies move on well before they pay off any significant portion of their subsidy. In other cases jurisdictions bestow tax breaks to gain jobs--only to see those jobs go to residents of other jurisdictions. Even worse, small tax-payers in the "winning" jurisdictions may end up subsidizing the "big catch." In Wyandotte County, Kansas, for example, taxes on a $100,000 house are $250 higher each year to pay for tax breaks to retain a General Motors manufacturing plant. The area's poorest residents are paying the State's highest property taxes to fund a tax break for the largest corporation in America. The cost per job saved in Wyandotte was roughly $320,000.

Companies are well aware of the influence they wield in such a competitive climate. A recent Office of Technology Assessment report revealed that a large regional bank that was planning to locate a new facility in the downtown was also planning to threaten to locate in an adjacent state in order to leverage incentives from the city government. And, in the last several years, New York City has provided massive subsidies to corporations to keep them from moving to New Jersey or Connecticut--$235 million to Chase Manhattan Bank, $98 million to the National Broadcasting Company, and $97 million to Citicorp.

Services and Public Goods

Senior officials at the Federal Reserve Bank of Minnesota, Melvin Burstein and Arthur Rolnick, argue that competitive subsidies typically result in local governments that under- provide public services in order to subsidize large corporations. New York City's recent experience illustrates this public cost. No companies moved, so no locational efficiencies were gained. But due to competition with its neighbors, the city offered subsidies; tax revenues were dramatically reduced. The result was a transfer of wealth from the public sector to the private sector. Production of public goods in New York City, such as education, transportation infrastructure, and environmental protection, were either reduced or the city increased other tax rates.

Rio Rancho, New Mexico provides another good example of how public services can suffer when public wealth is transferred to the private sector through incentives. In locating its new semi- conductor plant, Intel presented local governments with its incentives "wish list" which included 104 different tax breaks, work force subsidies, and regulatory relief requests, among other things. Rio Rancho offered a $114 million incentive package and landed the plant in 1993. By 1994, the town found itself unable to afford schools for the children of the families that came with the semiconductor plant. The community eventually floated an $8 billion industrial revenue bond for Intel. Intel then agreed to ante up $28.5 million for schools, but was careful to note that the state had neglected its responsibilities.

The State and Federal Roles

Although it seems logical for states to discourage such intra- state competition, state governments often exacerbate the problem. Artificial business relocations, spurred by subsidies, compromise local governments' ability to support themselves financially. State incentives could target new business incentives and retainer packages to particular places that make the best use of existing infrastructure. But most states have no such strategic or coordinated plans, so state policies tend to enable and reinforce current trends. For example, in an effort to keep Sears in the State, Illinois provided $110 million to move the Sears headquarters out of Chicago to Hoffman Estates, an outer suburb with little public transit access. Motorola also landed subsidies for its new plant 70 miles from downtown Chicago. These policies that result in the abandonment of the central city will end up costing all the state's residents socially and economically.

The federal government also has a role in spurring and supporting competition between jurisdictions. Ironically, federal programs helped to create the large numbers of local jurisdictions that exist in metropolitan areas today. Federal subsidies for highways, sewers, home mortgages, and electrification helped suburban areas grow and become competitive with their urban counterparts. At times, federal outlays accounted for as much as 40% of expenditures for local infrastructure such as roads, sewers and water. These subsidies enabled wholly residential suburban jurisdictions to survive without a business tax-revenue base. By 1991 however, the federal share of these same expenditures had dropped below 25%. As a result, new and existing suburban bedroom communities are an increasing drain on local tax bases. Their need for new business tax base is magnified and increases competition between local governments. Ironically, as was seen in the New York City region, increased local government competition means businesses have greater power to reduce overall business tax base for a given region.

What Next?

As long as any individual jurisdictions offer incentives to attract businesses, surrounding jurisdictions will be forced to follow suit. Competition will also continue to erode the overall business tax base within a region, increasing the strain on small property owners and other small tax payers. Where will it end?

Some jurisdictions have taken steps to change the motivations that local governments face. The city of Minneapolis/St. Paul has an innovative tax base sharing program which allows local governments to benefit regardless of where a business locates within the region. Virginia's Prince William's County recently began targeting medium and smaller size businesses instead of fighting a losing battle for the "big catch." Though the county sacrifices the political glamour of a huge tax base, the actual tax rate per dollar of business is frequently higher for small businesses than for large businesses with incentive packages. In Kansas City, for instance, a construction company pays approximately $8,000 in taxes. If they were to pay the same rate as the incentive packaged skyscraper, One Kansas City Place, they would only pay about $140. In addition to better tax revenues, Prince William's may also create more jobs--a lot more. According to a report by the Small Business Administration, small businesses (firms with fewer than 100 employees) created 2 million jobs between 1991 and 1993. Businesses with over 100 employees created roughly 280 thousand jobs in the same period.

While some jurisdictions have responded to inter- jurisdictional competition by changing their individual economic development strategies and others by changing local incentives, the vast majority have simply sought to compete more fiercely. They're creating new earnings tax credits, providing more infrastructure, and finding other ways to create financial breaks for large corporations. Localities need to recognize their "enlightened self-interest" as regions and begin to act together, rather than in competition with each other. Regional economies may be on the competitive front lines in the restructured world economy. Recent studies have offered some evidence that the health of regional metropolitan economies requires both healthy suburbs and healthy central cities. Jurisdictions that work together to increase their regional competitiveness and share the benefits may position themselves well for reaping the rewards of the new economy.

State and federal governments meanwhile must change their role in supporting local competition. They can start by ensuring that federal and state programs create their intended values, for example training prospective employees, rather than facilitating business relocations from one side of a region to the other. As responsibilities are devolved from the federal to the state and local level, there will be an even greater financial need for tax base at the local level. It remains to be seen if this need will fuel further competition, degradation of regional tax base, increased service reductions, and increased burdens for small tax payers. In the face of such financial burdens, localities would do well to find new solutions which prepare the United States to compete in the new economy.

Geoffrey Anderson is a Regulatory Impact Analyst in the Environmental Protection Agency's Office of Policy, Planning and Evaluation. He works on the Sustainable Communities Task Force of the President's Council on Sustainable Development This article drew largely upon the following: Neal Pearce, "Divided We Sprawl, December 17, 1995; Office of Technology Assessment,, "The Technological Reshaping of America, ~ September 1995; Federal Reserve Bank of Minneapolis 1994 Annual Report., "Congress Should End the Economic War Among The State, ~ 1995; and David Friedman, "The New Civil War," in The State of SmaD Business, 1996.

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