Are politicians and government bureaucrats better at identifying investment opportunities than capitalists and bankers?
Arkansas officials regularly try their hand at choosing and wooing "winners" by providing tax breaks and subsidies to favored businesses through incentive programs such as the Quick Action Closing Fund (QACF). However, the recent bankruptcy filing of Remington Outdoor Co. provides a cautionary tale for taxpayers.
In January of 2016, the Arkansas Democrat-Gazette reported that Remington would be expanding its Lonoke operation by 84 jobs. In return, the state provided the company cash rebates, sales- and use-tax credits, and a $2.5 million cash grant from the QACF. Yet the company filed for Chapter 11 bankruptcy in March of this year, little more than two years after announcing the government aid.
Remington is not the only company to receive incentives from the state only to go bankrupt. In 2010, wind turbine mainframe manufacturer Beckmann Volmer announced plans to create 300 jobs at a new facility in Osceola. The state of Arkansas offered approximately $4 million in incentives, including $1.5 million cash from the QACF. However, Beckmann Volmer was bankrupt by 2014.
Unfortunately for taxpayers, QACF annual reports indicate that none of the $1.5 million grant was returned to the state.
While ribbon-cuttings for companies like Beckmann Volmer and Remington make front-page news and photo opportunities, public officials have no special abilities or knowledge that make them better investors than other financially incentivized actors in a market. Instead of answering the siren's song by flinging millions of dollars overboard, Arkansans should stop up their ears and steer the ship, remembering two fundamental economic issues.
First, providing tax breaks and subsidies to individual businesses does not improve resource allocation, but instead distorts the market signals that allow for efficient resource allocation. Subsidies lower prices for government-favored firms, but other firms must pay full price. This means that subsidized firms may be able to sell products at a lower cost, hire more or better labor, or obtain cheaper credit than their unassisted competitors. Naturally, this encourages investment to shift away from other companies in favor of subsidized companies.
However, these subsidized companies may not have warranted the investment had it not been for the government-granted cost advantage. Instead, investors may have chosen to fund other companies that presented better opportunities.
In other words, providing incentives to select companies risks inviting bad firms to our state at the expense of good ones.
The second issue is that providing targeted subsidies can actually incentivize politicians and business owners and operators to be too risky because they share the risk with others. Economists call this "moral hazard"; everyone else calls this "spending other people's money." When public officials provide taxpayer-funded subsidies to businesses like Remington and Beckmann Volmer, taxpayers bear the risk. It is the taxpayers' money that is lost when these projects fail.
Public officials may try to protect taxpayers by using clawback agreements which require companies to repay incentives if employment targets are not reached. But clawbacks are only effective when enforced.
Consider, for instance, a January 2014 Democrat-Gazette article revealing that Hewlett-Packard in Conway repaid just 4.59 percent of a $10 million QACF grant despite missing employment targets by 30-40 percent. Clawback enforcement becomes even more difficult when projects go bankrupt, as evidenced by Beckmann Volmer's failure to repay its $1.5 million grant.
Public officials want growth and opportunities for Arkansans. But providing tax breaks and subsidies to select businesses does not get us there. Rather, it distorts the price signals that encourage responsible resource allocation and can lead to unnecessary risk-taking.
Taxing residents to fund economic development projects means reducing taxpayers' freedom of choice to spend and invest their money as they see fit. Instead of investing in their own projects like a family trip, a kitchen renovation, or their own small business, their money is invested in projects chosen by officials.
Unfortunately for Arkansas taxpayers, this includes bankrupt companies.
Jacob Bundrick is a policy analyst with the Arkansas Center for Research in Economics (ACRE) at the University of Central Arkansas. The views expressed are those of the author and do not necessarily reflect those of UCA.
Editorial on 05/10/2018