In a previous post, I concluded that under some conditions, competition among states in investment in early childhood education could be a good thing. I argued that such competition could meet two of Harvard professor John Donahue’s criteria for devolving a policy area to the states: “where external impacts are minor or manageable, … and where competition boosts efficiency instead of inspiring destructive strategies…”
In contrast, competition among states in business incentives makes less sense. It makes less sense because business incentives clearly do not meet the needed criteria for being a policy area in which authority should be devolved to the states.
For business incentives, “external impacts” are NOT “minor or manageable”. Rather, these external impacts are a majority of the impact. In chapter 10 of Investing in Kids, I conclude that business incentives have negative external impacts on other states of about 79% of their own-state impact. That is, if a given business incentive offered by state X increases per capita earnings in that state by $Y, that incentive will reduce per capita earnings in other states by 79% of $Y.
These negative external impacts are less true for business incentives that are not tax or financial incentives, but rather provide services to individual businesses to boost productivity. These productivity-boosting business incentives include customized job training and manufacturing extension services. Such business services can boost the overall productivity of the U.S. economy.
Competition among states in business incentives encourages excessive use of business tax incentives whose national benefits are only 21% of the benefits for that state. Competition among states distorts the use of business incentives away from services that would boost national productivity.
Ideally, federal policy would seek to restrict states’ use of business tax incentives. As I outline in Investing in Kids, and in a previous blog post, the European Union provides one model for such federal regulation.