Efforts to curtail tax-incentive bidding wars continue despite warnings about the legality of a multistate compact, as officials look for ways to battle what they increasingly view as a zero-sum game.
As of press time, legislation has been filed in 14 states to create or study an interstate compact that would end company-specific subsidies and establish a governing board to build on the agreement. The latest is Connecticut H.B. 5460, introduced by the Finance, Revenue, and Bonding Committee.
However, agreement among the states doesn’t necessarily mean the compact will pass legal muster under congressional authority. For example, the federal compact clause requires the consent of Congress if a compact infringes on federal authority, Rick Masters, special counsel for interstate compacts at the Council on State Governments, told Tax Notes.
Masters also noted that there could be potential conflicts with the commerce clause, which prevents states from regulating interstate commerce. “The argument would be that it has to do with companies that would be engaged in selling goods and services to the United States,” he said. “If states are regulating or limiting how that’s done or the manner in which it’s accomplished, it’s probably fair to expect it will be argued that Congress would have to consent.”
The Compact
There are minor differences among some of the bills. For example, Utah’s H.B. 270 would take effect only after 50 states have joined, while New Hampshire's H.B. 1132 would only mandate a study on the compact.
And although some states' legislation use different names for the subject of the compact — for example, the target is corporate welfare in Hawaii, corporate giveaways in Alabama, and company-specific subsidies in Illinois — the goal is the same: to take the pressure off states to offer ever-larger incentives to lure companies from other states.
Illinois Rep. Bob Morgan (D) described it as "that pressure, that feeling that it’s a requirement because everyone else does it, so we have to do it.” Morgan, who sponsored his state's compact legislation (H.B. 4138), told Tax Notes: “We’ve used tax credits to support [a business] because it has threatened to leave the state. That’s anti-poaching, but we’ve [also] used tax credits to entice other businesses.”
The interstate compact legislation has two parts. First, it prohibits states from using company-specific subsidies to poach companies from other states who have signed the compact. Second, the legislation creates a board of compact administrators, staffed by each state, to improve upon the compact.
Decades of research have supported the conclusion that these types of tax incentives do not work, yet the addiction to “ribbon-cutting syndrome” keeps states on the losing end of the prisoners’ dilemma.
According to research by Nathan Jensen, professor of political science at the University of Texas, Austin, politicians can become addicted to the positive press generated by landing large projects in their districts. And as economist Timothy J. Bartik puts it, "Politically, it’s easier for an elected official to give away their successors' tax revenue.”
Bartik, a senior economist at the W.E. Upjohn Institute of Employment Research, has researched state and local economic development programs for nearly three decades. In his book Making Sense of Incentives: Taming Business Incentives to Promote Prosperity, Bartik found that incentives are the deciding factor in less than 25 percent of the location or expansion decisions of the affected businesses and that an area would have received 75 percent of the jobs without the use of incentives.
Research also shows that firm-specific subsidies often fail to achieve the promised economic results. In a paper published in January, Cailin Slattery of Columbia Business School and Owen Zidar of Princeton University estimated that states give out $30 billion in incentives each year with little economic gain to show for it. According to the paper, approximately one-quarter of all state and local business tax incentives were in the form of firm-specific subsidies, with one-third of all state incentive spending in 2014 going to 0.0072 percent of new firms; only 1.41 percent of all jobs were created by those firms.
The paper also found that low-income areas are more likely to offer higher incentives, and larger, more profitable companies are more likely to receive firm-specific subsidies. Business incentives equal nearly 40 percent of corporate tax revenue for the typical state.
Stretching Across Party Lines
“Instead of bipartisan, I’d call it multipartisan in nature,” Michael Farren, economist at the right-leaning Mercatus Center at George Mason University, told Tax Notes. “I’ve spoken to conservative, libertarian, progressive policymakers and even ones who say, 'I’m a democratic socialist.' All feel the same way — government shouldn’t be used for the wealthy, powerful, and influential to extract benefits from the rest of society.”
Farren recounted a townhall meeting in Arlington, Virginia, during Amazon.com Inc.’s HQ2 search, when a variety of left- and right-leaning groups were part of the crowd. After a member of the Democratic Party finished speaking, the microphone was handed to a Republican. “Someone said, ‘This is the first time ever that a socialist ever handed a Republican the microphone,’ which brought a laugh from everyone,” Farren said.
The multipartisan support for interstate cooperation may be one of its strongest pillars. Republicans have sponsored interstate compact legislation in four states and nine states have legislation sponsored by Democrats. The right-leaning Americans for Prosperity attended a news conference on the compact held by Democratic legislators in Illinois.
The Democratic Socialists of America protested generous subsidies in New York’s package for Amazon’s HQ2, and even the American Legislative Exchange Council, whose members widely benefit from large corporate subsidies, according to research from Good Jobs First, has published reports calling out “tax cronyism.”
And more than 150 individuals filed witness slips in support of Illinois’ H.B. 4138, with most advocating on behalf of themselves or as voters. The Illinois Retail Merchants Association, Illinois Chamber of Commerce, and Illinois Manufacturers’ Association — all of which oppose the compact legislation — did not respond to requests for comment by press time.
Trying Again
The 2020 effort toward a national cease-fire on corporate tax incentives isn't groundbreaking — five states filed similar legislation in 2019. The language of those bills said that the term “company-specific subsidy” included “any change in the general tax rate or valuation offered or presented by the state to a specific company that is not available to other similarly situated companies.”
“The 2019 version was more of a broad compact and essentially got rid of the practice [of offering corporate subsidies]. We learned there was some pushback on that and that it felt like too big a bite, so in the 2020 version we took what we learned and came up with this," Dan Johnson, an Illinois-based lobbyist with Progressive Public Affairs, told Tax Notes. Johnson helped kick-start the discussions in 2019 and has amplified the effort in 2020 by connecting legislators and keeping followers updated with his website, EndTaxGiveaways.org.
Johnson said the focus of the 2020 bills is on the most egregious form of subsidy, which is poaching an existing business from another state. “We start with the most problematic, obviously wasteful one, where you’re throwing public money at an existing business,” Johnson said. “It fits nicely with the compact. You only agree to not throw money at a business in a state if that state agrees to join the compact.”
Existing economic development programs, credits, and subsidies wouldn't be subject to the compact. Details on the types of incentives that would be prohibited would be hammered out by the multistate board that would be established under the compact legislation, according to Johnson, but could include company-specific property tax abatements or grants.
Greg LeRoy, executive director of Good Jobs First, told Tax Notes that he is happy to see the support and momentum toward ending those types of deals but is concerned the compact’s focus on company-specific incentives.
LeRoy pointed to the tax breaks Boeing has received from Washington state as an example of tax breaks that wouldn't be covered by a ban on company-specific incentives. “Everyone knows deals like that were written for Boeing, though they aren’t technically written for Boeing,” he said. “In Seattle and Puget Sound, there are 300 companies that benefit, but it’s a manufacturing aerospace tax credit program.”
One of the reasons these incentives are written so broadly is states’ troubled history with subsidizing private development and gift clauses in state constitutions, LeRoy added.
From Mississippi’s Reliance to Tesla Envy
“An interesting point is that the Boston Tea Party was not a protest on a tax increase, but a tax decrease only for the East India Co., so it was a targeted subsidy for the East India Co. That was what the Boston Tea Party was about,” Utah Rep. Marc Roberts (R), sponsor of H.B. 270, told other lawmakers at a House Government Operations Committee hearing on the bill February 21.
Though the reference to a founding event in the country’s history may have tipped committee members in favor of H.B. 270, to understand the flavor of more recent subsidies, look to the Erie Canal and Mississippi’s response to the Great Depression.
The Erie Canal, opened by New York in 1825, was funded through a revenue bond scheme and repaid after 20 years through tolls levied on canal users. After that, states began borrowing to build railroads, canals, and turnpikes to benefit private companies. By the time the economy entered a recession in the 1830s, eight states and one territory were in default on those loans, according to the Mercatus Center.
Following that, states began to implement provisions in their constitutions that would prevent public aid in the form of loaning credit, becoming a stockholder, or granting gifts to a private individual or corporation. In 1874 the U.S. Supreme Court ruled that states could levy taxes to fund only those projects that serve a public purpose.
“Over the following 40 years, the understanding of what constitutes a public use of money was more watered down in the courts, and that allowed for the current subsidy arms race to start,” Farren told Tax Notes.
Hugh Lawson White, then-mayor of Columbia, Mississippi, kicked off the modern era of tax subsidies in 1929 with the Balance Agriculture with Industry program. Connie Lester, professor of history at Mississippi State University, describes White’s approach:
Employing the services of a Chicago-based industrial relocation firm, White approached Reliance Manufacturing Company, a maker of men’s dress shirts and pajamas. The company expressed an interest in establishing a Columbia factory if the town would guarantee $85,000 for the construction of a building to house the plant. In return, Reliance promised to employ 300 workers (increasing to 700 workers) and to pump $1 million in wages into the local economy over ten years.
White gathered funds from local farmers, teachers, and businessmen and took out a loan to bring Reliance to Columbia. He later became governor of Mississippi and instituted this program statewide. The legislation authorizing it was described as a necessity to protect the people to circumvent the constitutional prohibitions, and the Mississippi Industrial Act passed in 1936.
The rest is history, though the supercharged version of tax credit shopping may have emerged in 2014, when Nevada granted Tesla Motors $1.3 billion to build a battery plant in the state. According to reporting from Bloomberg, the massive grant given to Tesla drew envy from Amazon’s Jeff Bezos, who then instigated a countrywide bidding war for Amazon HQ2.
Stewart, sponsor of Maryland's H.B. 525, told Tax Notes that the constituents he met while campaigning in 2018 were "concerned with Maryland's efforts to woo Amazon to locate HQ2 in the state."
"I heard from a lot of constituents when I was knocking on doors that were concerned" the state would "be losing out on taxpayer money and would have more infrastructure needs" if the company chose to locate in Maryland, Stewart said.
Despite Maryland's offer of $8.5 billion in tax incentives, Amazon chose to locate in Virginia, which offered as much as $750 million in state subsidies and up to $51 million in local subsidies. The commonwealth also pledged to invest $1.1 billion statewide in higher education for computer science and related fields and $250 million in an Innovation Campus at Virginia Tech.
Enforcement and the Law of the Land
Past attempts to end poaching using incentives have not gone well. One famous failure was the agreement signed by Connecticut, New York, and New Jersey in 1991, under which the states pledged to “forswear advertising that casts aspersions on another area in the region and . . . market the three states together to attract overseas companies and to increase tourism.” The pact was not binding, however, and less than 24 hours after it was signed New Jersey’s largest utility began an ad campaign promoting the advantages of business in the state, according to The New York Times.
One difference in the latest interstate compact legislation is that it includes an enforcement mechanism.
To join the interstate compact, each state would pass legislation prohibiting the use of these types of incentives and tasking the attorneys general of each member state with enforcing it. The compact would also grant taxpaying residents of any member state standing in the courts of any other member state to require the attorney general to enforce the compact.
The compact bears some similarities to the Multistate Tax Compact created in 1967 following fears of federal intervention to mandate uniformity in state corporate income taxes.
There are two principles underlying state compacts, according to Helen Hecht, general counsel of the Multistate Tax Commission: First, one legislature can’t bind another legislature, such that no lawmaker can pass a law that a future legislature can’t change; and second, states can enter into contracts but the contracts are subject to appropriation, and a recession would relieve a state of those contracts.
“Governments can make contracts, but a contract involves both sides giving up something of value to the other. If you don’t perform on the contract, then I have a right under contract law to ask you to do what you agreed to do. The problem with this is one legislature can’t bind a future legislature,” Hecht told Tax Notes.
California signed the Multistate Tax Compact in 1974 but passed in 1993 an alternative corporate tax apportionment provision without withdrawing from the compact. In 2010 Gillette Co. sued California to refund $34 million, arguing it should be allowed to use different apportionment methods authorized under the tax compact. In The Gillette Co. v. Franchise Tax Board, the question was asked whether the multistate compact was a compact binding the state to a uniform apportionment standard or a model law promoting the adoption of those uniform standards.
The California Supreme Court's 2015 decision in Gillette held that the compact was not binding and that it created no mutual obligations among the members.
Hecht said that the difference between Gillette's lawsuit and any potential lawsuit over the interstate compact is that states never sued each other over the multistate compact.
“They were not suing each other for performance and there was no other provision to do anything else,” Hecht said. “I think that had we had a provision in the compact that says, ‘If any state changes this provision [allowing a state to use the Uniform Division of Income for Tax Purposes Act], then a taxpayer affected by that has a right to bring a suit under this law.’ As long as that law is still on the books, then that would have created a right for a third party, besides just the members of the compact.”
Despite this, states still can’t bind future legislatures and states would be able to withdraw at any time as long as they pass a law repealing the interstate compact through their own legislatures.
“It’s a speed bump, if nothing else,” Hecht said.
Congress never sanctioned the multistate compact, yet the Supreme Court upheld its constitutionality in U.S. Steel v. Multistate Tax Commission in 1978, ruling that though the states gained bargaining power in working together, the pact did not authorize member states “to exercise any powers they could not exercise in its absence.”
In a 2019 report from the Mackinac Center for Public Policy and the 1889 Institute, titled "Multilateral Disarmament: A State Compact to End Corporate Welfare," the authors make the case for including a trigger provision in the interstate compact that would activate it once "enough states have signed on to constitute a three-fifths majority in the House and Senate, enough to ensure a successful cloture vote in the Senate." Once this happens, the party states would request their legislators to file a bill to get approval from Congress.
“Given that the power of the states to bind each other with these contracts is still uncertain, we would ask Congress to ban [the use of tax incentives] under the commerce clause,” James Hohman, director of fiscal policy at the Mackinac Center, told Tax Notes. “I also do think the ability of Congress to eliminate these programs in the states is clearer.”
A Quest for Cooperation
Future legislatures may be able to repeal states’ membership in the compact but politicians would run a political risk in striking a law with such broad and deep support. And although some say the compact could be found to violate the commerce clause, Congress could give its consent and states could let the compact simmer until a majority of states support it.
Indeed, state cooperation is the key to success, according to every person interviewed for this article.
The compact is “a structure for collaboration and cooperation beginning with the principle that we all want to phase out these corporate giveaways,” Johnson said. “It establishes a board, which can come up with consensus on amendments and enhancements so there’s a body and mechanism for experts and advocates to have a body to go make their pitch.”
There are signs lawmakers are showing interest in cooperation. In August the governors of Kansas and Missouri signed a truce ending the states’ incentives border war. And H.B. 4680 in Illinois would create a state-level prohibition on business poaching.
"I've heard interest from lawmakers on doing regional compacts as well," Hohman said. "I suspect there's a lot of interest in getting states to agree with doing more things, especially with how frustrated people are at getting things done at the federal level. There's other ways of doing things."
“One of the benefits of compacts is they create statutory uniformity among states without federal intervention,” according to Masters. “If you create a compact where states sign on to have good-faith conversations to place limits [on corporate subsidies], you shift the burden to the governing structure put under this compact.”