By Mr. Jacob Bundrick
Supporters of financial incentives for businesses argue that incentives are designed to protect the taxpayers who pay for them. Tax incentives generally pay out only after a company makes a business investment. An example is the tax credit for 1 percent of payroll that Elyxor will receive for creating 45 jobs over the next 5 years in North Little Rock. Governments will not award firms a job-creation tax credit if they do not create jobs, just as governments will not give firms a research and development tax credit if they do not engage in research and development.
Subsidies are different: they generally provide payments up front. Because of this, subsidies often come with clawback agreements, which allow governments to take back a portion of the granted money if a firm fails to create the agreed upon number of jobs or make the promised investment.
How Clawbacks Fail to Claw Back Tax Dollars
On the surface, clawbacks seem like a valuable safeguard that limits taxpayers’ risk. However, clawbacks work only as well as they are enforced. If governments don’t enforce them, taxpayers have minimal protection from failed projects.
Consider the case of Hewlett-Packard (HP) in Conway. HP received a $10 million grant from Arkansas’s Quick Action Closing Fund, which provides subsidies to select businesses that locate in Arkansas, in return for its promise to create 1,000 permanent, full-time jobs by the end of 2013. At the deadline, however, the Arkansas Democrat-Gazette reported that HP had failed to create approximately 40 percent of the jobs it promised. Did Arkansas’s government ask HP to pay back 40 percent of its grant? No. It asked HP to pay back only 4.59 percent of the grant it received and negotiated an agreement that would “encourage the company to continue hiring people,” according to Arkansas Business. But HP continued to underperform, as evidenced by a second clawback of $356,000 in early 2015. But even with both clawbacks, as of the end of fiscal year 2015, HP had been allowed to keep 91.85 percent of the money it received for providing only 60 percent of the jobs it promised, according to the Accounting of the Economic Development Incentive Quick Action Closing Fund as required by Act 510 of 2007.
Another problem with clawbacks is that they do not protect taxpayers when a company receiving a subsidy with a clawback agreement goes bankrupt. If this happens, there is little chance that taxpayers will see any money recouped. German manufacturer Beckmann Volmer in Osceola is a prime example. After receiving $1.5 million from the Quick Action Closing Fund, the company entered bankruptcy and has been unable to return any grant money to the fund.
Financial Incentives for Businesses and the Moral Hazard Problem
Financial incentives for businesses also create the problem of moral hazard. Moral hazard arises when people engage in risky activities that they otherwise would not because they share the risk with others. Put more simply, people tend to take more risk when using someone else’s money instead of their own. Politicians are willing to provide incentives to riskier ventures, such as wind turbine manufacturer Nordex in Jonesboro or Beckmann Volmer in Osceola, because they are using taxpayer money. Likewise, firms engage in riskier endeavors when they can use incentives to fund projects instead of making the investment with the company’s own money. The risk of the politician’s handout is spread among the taxpayers; it doesn’t fall on the politician or the benefiting firm. A failed project does not lead to a loss for the government or for the business, but for the taxpayer.
What Else Could Arkansans Get for Their Tax Dollars?
Politicians also largely overlook the opportunity costs of financial incentives. Opportunity costs are the alternatives one forgoes when using resources in a particular manner. In other words, what could a state have done with the money if it did not provide financial incentives?
One alternative use of incentive money would be to leave tax dollars in taxpayers’ hands. Individuals would keep more of the money they earn and use it in a manner that best suits their interests. For example, in 2013 alone, every taxpaying family in Arkansas would have had an extra $179 if the state had left incentive money from business tax incentives, the Quick Action Closing Fund, and Amendment 82 bonds in taxpayers’ hands.
Another alternative use of incentive money would be to work toward increasing the number of Arkansans with a college degree. University of California at Berkeley professor Enrico Moretti finds that cities with greater growth in their share of college graduates also experience greater growth in manufacturing plant productivity. This finding is important for Arkansas because according to the American Community Survey’s one-year estimates for 2014, only 21.4 percent of the state’s population age 25 and older has attained a bachelor’s degree or higher. Arkansas ranks eighth in this category among the nine neighboring states, which also include Alabama, Kansas, Louisiana, Mississippi, Missouri, Oklahoma, Tennessee, and Texas.
A third alternative use for incentive money would be to hire K–12 teachers. Arkansas had 8 critical academic licensure and endorsement shortage areas for the 2015–16 school year, and it has 10 critical academic licensure and endorsement shortage areas for the 2016–17 school year. The state also has 54 school districts with a critical shortage of teachers, according to the Arkansas Department of Education and the Arkansas Department of Higher Education. The state is providing corporate welfare to a handful of firms while many of Arkansas’s children are not receiving the education they deserve. Using the 2013 cost of financial incentives ($218,563,864), Arkansas could have hired 4,500 teachers for one year at the average Arkansas teacher salary ($48,575 for 2014-15 school year) instead of providing favors to a handful of firms.
Conclusion
When governments give financial incentives such as tax breaks and subsidies to businesses, the taxpayer often becomes an unwitting victim. Companies don’t always fulfill the promises they make in exchange for the money they receive, and governments don’t always ask for that money back when companies fail to make good on their promises. When states like Arkansas use taxpayer money to fund hit-or-miss economic development projects, they are more than likely bypassing more productive uses of that money.