Tax Notes Today State reporter Aaron Davis discusses the recent state efforts to clamp down on tax-incentive bidding wars by forming a multistate compact.
The interview has been edited for length and clarity.
David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: incentives truce. For years, states have enticed businesses to relocate or expand operations by offering tax breaks and other financial incentives. But following a recent high-profile bidding war, some have called for a cease-fire. Here to talk about recent efforts to limit incentives competition through an interstate compact is Tax Notes reporter Aaron Davis. Aaron, welcome back.
Aaron Davis: Hi, thanks for having me.
David Stewart: Why don't we start off with you explaining these interstate compacts. What is the idea behind them?
Aaron Davis: These interstate compacts are mostly an attempt by states to set some rules on the battlefield of tax incentives and collectively agree not to use particular economic development tools against each other as they compete for businesses. Many of the proponents behind this point to the famous game theory paradox called the prisoner's dilemma as a good example. In that situation, you have two prisoners in solitary confinement. Prosecutors offer them a plea bargain to betray their confederate. They can both betray each other and lose, one can betray the other and win, or they can both remain silent and be better off than when they betray each other.
Here, the prosecutors of the companies and site selection firms and the states are the prisoners who feel compelled to offer larger and larger tax breaks and grants to win the political award of bringing a business to your state. But the compact itself starts off with a small buy-in, almost similar to a prisoner exchange.
In this case, states would need to agree to end company-specific subsidies to poach businesses from another compact state. Once two states agree, the interstate compact is created, and a board of directors is appointed. Over time, additional economic development strategies and policies can be agreed upon so that less tax dollars are lost from what appears to be a zero-sum competition.
David Stewart: What brought about this recent push for compacts?
Aaron Davis: It seems like the public spectacle of the Amazon HQ2 search embarrassed or angered many of the politicians and their constituents after they saw immense sums and services offered to what, at the time, was the largest company in the world. That display certainly soured many people and that in turn informed many politicians who agreed to work on legislation for this compact. It was also a big motivating factor for Dan Johnson, the Chicago-based lobbyist who helped connect politicians to initially collaborate on this.
I've also heard about resurging popularity of compacts as a reflection of citizens' dwindling faith in the effectiveness of the federal government. They're going about doing it themselves. In looking around, I saw compacts to commit to the national popular vote rather than the Electoral College. There were also many compacts to address the interstate licensing issues and some to create Second Amendment sanctuaries.
David Stewart: Let's take a step back and talk a bit about the history of tax incentives and how they first became used to entice businesses.
Aaron Davis: The history actually goes back a long ways. There was early example of a tax incentive war from the 16th century, when Italian port cities' competition with one another essentially eliminated duties and excise taxes. But there are instances a little bit more recent. Many of our states have particular rules written into their constitutions to prevent gifts and/or subsidies to private enterprise.
This started back around 1825, when the Erie Canal had opened. It was funded through a revenue bond scheme and repaid after 20 years through tolls on canal users. It was a wild success, and a lot of states started funding railroads, canals, and public projects. After a dip in the economy, a lot of them couldn't be paid back and states were on the hook. So around that time, many states put into their constitutions prohibitions on funding private enterprise. For a while that held, but over the years it was eroded through court decisions until around the 1920s.
There was one mayor in Columbia, Mississippi, Hugh Lawson White, who kicked off the modern flavor of tax subsidies with this program called Balance Agriculture with Industry program. He got a lot of the town together to commit to building infrastructure for this one dress shirt and pajama making company called the Reliance Manufacturing Company. That brought this company down to Columbia, Mississippi. It was a wild success at the time because they also had job training programs. It did help bring that town some economic success.
Later he became governor of Mississippi, and implemented this statewide, so this was no longer private money funding the relocation of industry. It became public money, and that passed through the courts. That was considered legal and did not violate those gift clauses.
After that, the rest is history. It continued on from there through economic development agencies and programs, and all the way up to a modern supercharging of it, no pun intended here, when, in 2014 Jeff Bezos, the head of Amazon, learned a little bit about incentives granted to the Tesla Motors company in Nevada. According to reporting from Bloomberg it was about $1.3 billion. He was a little bit envious of that large of an award and told his people to go out and find a bigger one. And there we have HQ2.
David Stewart: How big of an issue are tax incentives today? How much money are we talking about?
Aaron Davis: There's some disagreement on how to count it. But research from Tim Bartik at the Upjohn Institute places it about $45 billion annually. But a recent paper, published by Cailin Slattery of Columbia Business School and Owen Zidar of Princeton, pegged the low end at around $30 billion. In comparison, NASA's budget is $22.6 billion.
David Stewart: What states are proposing to curb tax incentives?
Aaron Davis: Right now we've got 14: Alabama, Arizona, Connecticut, Delaware, Florida, Hawaii, Illinois, Iowa, Maryland, New York, Rhode Island, and West Virginia. New Hampshire has a bill, but it is more to study what would happen if they join this.
Utah has a slightly different bill in that it has gone the farthest so far. That bill has gotten out of committee and was approved, not by the full legislature. It also only comes into effect when all 50 states actually sign an interstate compact, and it has more of a different direction in both impact and intention. It's called an interstate compact to promote economic cooperation, something close to that. It's more so a pro-business approach rather than a limiting of economic tools.
David Stewart: Is there one state that's leading this effort? How is this happening?
Aaron Davis: One state that did file in the previous wave that also refiled and has been proactive on social media as well as outreach efforts has been New York. Illinois has as well. They've hosted a lot of press conferences there as well as gotten a lot of the word out and promoted it.
But New York had filed bills in the previous wave, when there were only five states who were filing these interstate compact bills, and they filed in this round. I believe New York Assemblymember Ron Kim (D) has been very active on this, both writing op-eds as well as promoting this legislation.
David Stewart: If I remember correctly, both New York and Illinois were deep into the competition to get HQ2.
Aaron Davis: Absolutely. I think that might have been the double-edged sword. By involving themselves so deeply in a pitch for their state to Amazon HQ2, it soured some voters and legislators there. Those who look at the budgets every day and say, "We don't have money for this," saw large packages put together for Amazon and felt like they needed to lead the charge in ending that sort of thing.
David Stewart: Are there any states that actively don't want to join this? Maybe they see it as an opportunity to capitalize on being the only players left competing for these businesses?
Aaron Davis: With this compact they wouldn't be able to capitalize on any new business, since the compact would only end the tax incentive wars or particular devices between the states who signed the agreement. These states that have signed the compact are still free to use any of these economic development tools in pursuit of businesses in states that haven't signed the compact. If you have not signed the compact, you still are an open target.
But like with Utah, there are some states that want to take a different approach, but are still interested in it. I think most legislators would prefer to save a dime on certain company relocations, but there haven't been any states that have actively opposed it.
David Stewart: Assuming that some of these compacts do come about and get agreed to, how would they be enforced?
Aaron Davis: Part of the enforcement is a behavioral thing, much like with prisoner's dilemma. You don't want to sell out your compatriot because if this thing keeps happening, they're going to be the one who sells you out next time. So part of it is behavioral.
But another part is that it is a compact that each state has given taxpayers in other states standing in their courts to enforce the letter of the law in the compact. This is still up in the air as to how this would exactly work. But say Illinois violated the compact, taxpayers in New York would be able to potentially sue in Illinois courts to have the attorney general enforce the laws in the compact.
With compact law, it's still a little bit tenuous. The Supreme Court has not taken up several cases that would resolve some lingering questions.
Another thing is that many people have criticized it by saying that in the end, states are still free, legislators are still free to leave the compact when a good deal comes around. So that is one chink in the enforcement. But it still is enforced through both a shared willingness to lay down arms as well as granting standing in their states' courts.
David Stewart: You recently wrote an excellent piece about this. Did you talk to anyone who raised issues about these proposed compacts?
Aaron Davis: Certainly. There were several people who raised issues. A lot of people on the positive side did say one of the main benefits is that it shows people are willing to engage in this. But some of the main criticisms people have had are that the compact could potentially run afoul of the commerce clause, particularly in regulating interstate commerce, because it gets a little convoluted from there. I can't give an exact example at the moment, but it would be potentially regulating grants and or businesses from even site selection firms, things like that, from being able to engage in business.
But there were also other criticisms. Enforcement would not be as solid if Congress had actually enshrined this compact into law. If federal law was supporting this compact, then that would make it far more of a solid and enforceable set of rules. There were also worries about it, particularly that its initial buy-in to end company-specific subsidies doesn't get to some of the biggest, more egregious deals. Particularly, the largest deal was actually for Boeing, and that deal was written to be a narrowly targeted industry deal that targeted the aerospace industry. But there really is one. The biggest tree in the forest is Boeing. So it wasn't a company-specific deal, but it ended up being that way.
David Stewart: Aaron, I thank you very much for coming here. This has been fascinating, and I'm sure we'll have you back to talk if these compacts go anywhere.
Aaron Davis: Thank you very much. I appreciate it.