Education, not subsidies, brings prosperity,
Fed expert says

By JAN FALSTAD, Billings Gazette - May 19, 2004

The words "economic development" are used again and again to justify spending public money on incentive packages to lure new jobs or retain existing jobs.

Speaking out against public subsidies to private industry can be like trashing mom and apple pie. But, there are plenty of critics who argue there are better ways to boost the economy than having states or cities outbid each other for jobs.

The billions of dollars poured into economic development each year is largely misspent, suggests Art Rolnick, director of research for the Ninth Federal Reserve Bank in Minneapolis.

The money would be better spent educating needy pre-schoolers, he said. Getting kids ready for formal education as early as kindergarten is the real return on tax money.

"The return on investment from early childhood development is extraordinary, resulting in better working public schools, more educated workers and less crime," he said. "Yet, early child development is rarely considered as an economic development measure."

Florida, under Republican Gov. Jeb Bush, and Oklahoma have adopted the early-education philosophy. Florida passed a constitutional amendment requiring education for all four-year-olds, not just at-risk kids as Rolnick advocates.

Studies prove that education continues to pay off.

In the mid-1980s, a person with a college degree earned 40 percent more over his or her lifetime than someone with a high-school degree. The spread today is about 80 percent and growing.

A person with a master's or doctorate degree outearned a high-school graduate by 60 percent in the mid-1980s. The gap today tops 100 percent.

By one measure, Montana gets high marks for educating children. Montana finished eighth highest among the states with nearly 90 percent of its students completing high school in 2002. Minnesota led the nation in high school grads with 92 percent finishing.

In Montana, about 20 percent of the children age six or younger live in poverty. The state may have to find as much as $350 million by October of 2005 to cure what a district judge recently ruled was inadequate funding for education.

In addition, Montana faces a financial shortfall estimated at $45 million to $100 million, meaning the fight for tax dollars will grow more intense during next year's legislative session.

Montana's two-year budget includes $2.6 billion in state money.

Directing the dollars
Spending public tax dollars to produce jobs doesn't work for a couple of reasons, Rolnick said.

Public subsidies distort the marketplace, giving one company an advantage over its rivals.

In Minneapolis, for example, public subsidies helped build the world-renowned Mall of America in the suburb of Bloomington. While the mall has become a huge tourist draw, Rolnick said it drained business from downtown Minneapolis and St. Paul.

That, in turn, spawned some corporate cannibalism in the Twin Cities.

In the late 1990s, St. Paul subsidized Lawson Software millions of dollars to move from Minneapolis to its downtown, he said.

"From the state's point of view, there are no new jobs," he said. "They just moved the jobs across the Mississippi River."

Tony Schertler, economic development manager for the city of St. Paul, said the $110 million deal was more complex than that.

The city gave the subsidies to the developer, not Lawson. The deal got rid of a blighted downtown block and got a 14-story office tower on the tax rolls. The city spent about $41 million on the package. Half of that paid for a city owned parking garage which produces revenues for St. Paul.

Rolnick also criticized the state subsidy given Northwest Airlines, which promised to build a jet maintenance center in northern Minnesota providing high-paying mechanical jobs.

Instead, the airline built a reservations center employing far fewer people than promised. The state wrote the contract tightly and could have recalled the subsidies, Rolnick said, but instead legislators rewrote the law to accept the lower-paying jobs.

True entrepreneurship
There are some in Montana who agree with Rolnick, at least as far as incentives go.

Roger Koopman, president of the Bozeman-based Chamber of Private Enterprise, is philosophically opposed to providing subsidies to relocate business.

"When you unravel the whole thing and look at the basic principle, a bidding war against other states never works," Koopman said.

"The problem is that you tend to create winners and losers. If you've got government allocating money, it creates dependency in place of true entrepreneurship," he said. The Chamber of Private Enterprise is open to private businesses that pledge to refuse government subsidies.

Key factors in a move
When a business decides to relocate, Rolnick said studies show that it looks first at whether the new city has a quality workforce, good schools and whether the location works logistically.

"Low on the list are subsidies. Most will say - at least after they've received their subsidy - that they are low on the list," he said. "We estimate that 80 percent of the subsidies go to businesses that would have come anyway."

Rolnick readily admitted that that is a "very soft number" based on interviews with executives, not hard numbers.

Hard numbers are difficult to come by, he said. There are too many variables and assumptions to conduct good science.

His viewpoint is supported by a Economic Policy Institute study which found that state and local taxes make up just 0.8 percent of a company's costs, so they aren't a big factor in a company's decision to expand or move.

"Luring industries with tax breaks is a boondoggle," the study found.

It also said that when tax dollars are skimmed off public programs like improving education or roads, economic incentives may hurt the economy, not help it.

"The bottom line is that state and local taxes, at their current low levels, may be largely irrelevant to business investment decisions," the report said.

Boosteriam political, not economic?
Subsidies with tax dollars can also result in conflicts of interest. "Crony capitalism" is too strong a word, Rolnick said, but politicians tend to see that the public subsidies go to businesses that are or become supporters.

"We think it's bad economy. It's bad political science and it's bad from a political perspective," he said.

Politicians, he said, like to point to a new factory or building as proof they've accomplished something economically, so that's why tax subsidies keep winning over longer-term projects like improving education.

Congress needs to act, Rolnick said, to stop what the states from playing what he calls the "zero-sum game of economic development."

Rolnick worked to have a bill introduced in the U.S. Congress in 1999 banning states from competing with each other with public tax dollars. The bill would require private companies to declare public subsidies as income and tax those subsidies. Such subsidies are now exempt from taxes, he said.

He pointed to the big push by the Minnesota Vikings and Minnesota Twins to get tax dollar subsidies to build two sports stadiums for each team 22 years after the Metrodome was constructed. Eliminating tax breaks for the subsidies is one way, he said.

On May 4, the $1.2 billion bill to subsidize the stadiums passed the House Taxes Committee on a 15-13 vote.

The bill limits the state subsidy to $100 million out of $535 million cost for the Twins. The state funding for the Vikings is limited at $185 million out of a $600 million stadium.

The teams would have to pay one-third of the costs and the community that lands the stadium must pay the balance. The bill was later killed, then potentially given new life in a trade for a gambling casino in northern Minnesota.

Taking away the tax benefits would help keep private-sector decisions like stadiums on the right economic track, Rolnick said.

"They would have to make their decisions based on where the fans are or where the best location is," he said.

However, that big picture view, Rolnick said, isn't shared by most cities as seen in the competition between Butte and Billings to win the Bresnan Communications call center and its 100 jobs.

Following 18 months of deliberations, Bresnan chose Billings after receiving promises of $1.6 million in tax subsidies and other incentives from the Big Sky Economic Development Authority.

"From Montana's point of view, why are they letting them spend public dollars for this when they could be funding schools or roads or lowering taxes on all businesses?" he asked.

"But from a parochial view, if I was the mayor of Billings, I'd be out there doing the same thing."

For more information:
To read Art Rolnick's papers, go to: http://minneapolisfed.org/pubs/fedgaz/03 and search for "Early Childhood Development: Economic Development with a High Public Return" and "Congress Should End the Economic War Among the States: Federal Reserve Bank of Minneapolis Annual Report Essay."
To read the Economic Policy Institute study, go to: www.epinet.org and look for "Rethinking Growth Strategies"