Federal COVID Relief Imposes Truce in States’ Corporate Welfare Wars

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A decade ago, then-Vice President Biden was caught on a live microphone describing the Affordable Care Act’s passage as “a big f**king deal.” The same could be said about an 11th-hour addition to the American Rescue Plan Act (ARPA), which arguably imposes a ceasefire in the interstate corporate welfare war.

The clause in question, added by Senator Joe Manchin (D-W.Va), prohibits states from using the $220 billion they’ll receive in ARPA relief to cut taxes. The restriction is rigorous: Until 2025, no state may “directly or indirectly” use federal relief funds to offset reductions in net tax revenues through “a reduction in a [tax] rate, a rebate, a deduction, a credit, or otherwise” or by delaying the imposition of any tax or tax increase.

The legislation is broad. States that accept federal relief funds might be legally challenged if they reduce any instance of taxation relative to the current paradigm. This is an unfortunate attack on federalism, but there is a silver lining: It clearly should prohibit any new targeted tax reductions granted by state governments to privileged corporations to counter the negative economic impacts of COVID-19.

That represents progress. State and local governments already spend an estimated $95 billion on economic development subsidies every year — enough to fund the 11 smallest state budgets, combined. Alternatively, it’s enough to fund all federal food assistance programs, with enough left to build two nuclear aircraft carriers, every single year.

Worse, academic research consistently finds subsidies to be a waste of money that are more likely to slow economic growth than to stimulate it. Subsidies reduce competition, crowd out small businesses, and force other taxpayers to bear a larger share of the overall tax burden. Using subsidies to promote economic development is like using leeches to treat strep throat.

But policymakers are caught in a prisoner’s dilemma. Many offer subsidies as a defensive reflex, because even wasteful policy seems better than allowing your neighbors to poach local businesses and jobs. As former Illinois Governor Jim Edgar said, “If you’ve got some states doing it, it’s hard for the others not to do it. It’s like unilaterally disarming.”

While ARPA doesn’t roll back already-granted subsidies, halting new boondoggles would give political leaders the opportunity to confront core issues of economic opportunity and equity, rather than chase the next ribbon-cutting ceremony. It’s especially important as states consider how to jumpstart post-COVID economic growth, like New Jersey’s misguided $14 billion tax incentive program.

ARPA’s expansive state tax restriction has already prompted legal challenges. However, because state and local subsidies interfere with interstate commerce, their regulation is squarely within congressional authority. Subsidies disrupt the interstate allocation of capital and labor, and virtually every program requires that projects affect cross-border business investment or job growth. Even if ARPA’s ambition to commandeer state tax policy is struck down, its prohibitions on economic development subsidies should remain standing

The trade barriers states levied against each other in the early republic were a primary reason James Madison pushed for a constitutional convention and interstate commerce protections. Indeed, much of America’s rapid economic growth is attributable to the Constitution’s creation of the world’s largest common market. But modern economic development programs, like the trade barriers before them, bleed away future growth.

The impact of the subsidy ban isn’t solely up to the courts, either. The Treasury Department is responsible for interpreting it, making rules, and enforcing compliance. By singling out various tax abatements, ARPA shows congressional intent to avoid underwriting every competitor in the corporate welfare war.

And while the bill doesn’t explicitly apply a similar restriction to local governments’ $130 billion relief package, the Treasury should hold all of a state’s subdivisions — cities, counties, special districts, economic development authorities, or any other public or quasi-private body that is a creation of the state government or which receives state funding — to the same standards. Doing so is appropriate because ARPA’s prohibition of “indirect” tax reductions recognizes the fungibility of relief grants.

Furthermore, the bill’s language arguably includes cash subsidies, property grants, or special services that, in effect, reduce corporate tax responsibility. After all, tax expenditures and direct grants are just different forms of subsidy intended to achieve the same outcome. Any other interpretation would neuter congressional intent, since states could get around the restriction by using local governments as pass-through entities, or simply provide corporations with direct grants instead of tax breaks.

Lastly, because the broad body of academic research finds that subsidies are a waste of public funds — neither swaying corporations’ location or expansion decisions, nor leading to measurable economic growth — there’s a clear argument that economic development subsidies ought to be considered the absolute lowest priority of government spending. Thus, spending on “bottom of the list” economic development subsidies should logically be attributed to budget expansions enabled by ARPA’s COVID-19 relief.

A temporary truce in the corporate welfare war offers a space for saner heads to prevail. Multiple Republican senators and representatives have already proposed legislation to roll back ARPA’s restrictions on state tax policy. But Republicans should make sure to not throw the baby out with the bathwater. A federal ban on states’ corporate welfare war should remain in place, because it really is “a big f**king deal.”

Michael D. Farren is a research fellow with the Mercatus Center at George Mason University. John Mozena is the president of the Center for Economic Accountability. They are authors of the Mercatus Center working paper “Federal Pandemic Relief Could End the Interstate Economic Development Arms Race.”

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