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Business and Regulation
Economic Development

While economic development has dominated the agendas of many governors, legislators, and local elected officials in North Carolina, it is one of the most misunderstood activities that governments undertake. The political incentive to attract media attention through job announcements is frequently a substitute for a policy that maintains a balanced, efficient, and fair economic environment. Such a policy would provide the maximum amount of opportunity and prosperity for North Carolinians. It would respect the rule of law, protect private property, promote competition, and allow markets to operate freely.

Defining Economic Development

Just what does the term “economic development” mean? Is it population growth? Is it per-capita income growth? Is it a reduction in the reported unemployment rate? While these measures are often useful, they provide us with very little information about the real economic well-being of citizens. Is population growth desirable if it does not pay for itself and results in higher taxes? Is per-capita income growth desirable if inflation and taxes consume it all? Are county unemployment rates reliable enough to disregard the N.C. Constitution’s requirement for a fair and equitable tax system by basing tax credits on them? While these indicators can be useful tools for private businesses and government officials, a low ranking should not be used to justify state intervention in private markets that are more complex than such numbers can convey.

The term “economic development” is not mentioned in the state constitution, so until recently state and local economic development programs were basically operating with no clear authority to intervene in the economy. On March 8, 1996, the N.C. Supreme Court gave governments an “economic development permission slip.” The court ruled by a 5-2 vote in Maready v. Winston-Salem that publicly funded economic development incentives constituted a public purpose consistent with the intent of the constitution.

The Corporate Welfare Budget

The acceptance of economic development as a government responsibility has led to state and local policies that have collectively been called “corporate welfare.” This category includes state tax and subsidy policies that favor individual businesses, selected industries, or certain geographic regions. Unlike the maintenance of low across-the-board tax rates or the provision of core public services such as education, highways, and public safety, corporate welfare doesn't benefit everyone. It requires public officials to intervene in private markets to decide which businesses or regions are worthy of support. This sets the stage for increased special-interest lobbying, strings-attached campaign contributions, and unethical behavior in public office.

A partial list of corporate welfare would include overseas advertising subsidies in the departments of Commerce and Agriculture, special marketing programs for industries as varied as film production and meat goat farming, state subsidies for private ventures such as the N.C. Biotechnology Center’s venture capital fund, below-cost state services offered to agricultural and other businesses, regional subsidies such as the state’s investment in the Global TransPark in Kinston, and special tax breaks for job creation in “distressed communities,” worker training, and research and development.

In its 2004 alternative budget, the Locke Foundation identified some $356 million in corporate subsidies and “economic development” tax credits. If these special programs were eliminated in favor of across-the-board tax reduction, North Carolina could reduce its relatively high corporate tax rate to 5 percent and repeal the personal income tax hike passed in 2001. Both actions would help to create a lower-cost environment in which businesses of all sizes could thrive, not just those large enough or powerful enough to attract political attention.

Research shows that government-subsidized economic development projects have few significant effects on business expansion or relocation decisions. For example, a 1999 study from the Kenan Institute of Private Enterprise at UNC-Chapel Hill concluded that “state incentives play only a marginal role in the location decisions of private firms.” Another study, by an economist with the General Accounting Office, found that most attempts by state governments to “guide” their economies fail. The report did identify three variables that had a statistically significant impact on state economic growth: the starting size of the state’s economy (smaller ones grew faster), marginal state and local tax rates (high is bad), and the extent of lobbying for political favor in the state, measured by the percentage of workers employed in government, law, and lobbying.

If targeted tax breaks and interference in the market don’t generate economic benefits, what does? A 1996 study for the Locke Foundation by N.C. State economist Mike Walden found that spending on law enforcement activities had a large payoff in jobs and income growth. Education and highways had modest payoffs. Other government spending reduced jobs and incomes because the taxes levied to finance them took money away from more productive private investments. These and other research findings suggest that the safest course for policymakers is to concentrate on doing basic tasks well, including tax and regulatory relief, rather than letting themselves be distracted by politics, media spin, and peddlers of dubious projects such as the Global TransPark, state grants to biotechnology companies, or the ill-fated N.C. Information Highway.

Recommendations

1. State and local leaders should phase out business recruitment and marketing programs, and end targeted incentives and subsidies for unprofitable enterprises, saving hundreds of millions of dollars annually.
2. State and local leaders should pursue economic development by improving core government services, such as public schools and highways, and by further reducing taxes and reforming the state’s antiquated tax code.

To view higher quality graphs, download Agenda 2004 [560KB Acrobat].