How Local Cronyism Hurts America's Cities

Nolan Gray is a writer at Market Urbanism and sharing a guest essay today on cronyism and the American town.

In the years following the havoc of the financial crisis, a curious thing happened: Americans formed two rival groups that shared a common goal. Despite their ideological differences, both the Tea Party movement and the Occupy movement wanted to end crony capitalism. In their own unique way, both camps criticized the bailouts, tax exemptions, and self-serving regulations that are draining the US economy. Yet both movements missed a far greater threat lurking right in their backyard: state and local development incentives.

Development incentives, also known as investment subsidies, are programs that hand out subsidies in order to affect the location of investment. In human terms, this is the process of robbing Peter—a local small business owner—in order to convince Paul—typically a savvy representative of a multinational company—to invest in a particular community.

A story might help to illustrate this process. Let’s say you’re a local official interested in fostering economic development in your small town.  A fancy representative from Big Box Inc. calls and tells you his company is considering opening a store in your community. That’s fantastic, you think. This will bring in plenty of jobs and tax revenue. But there’s a catch: They would love to come to your small town, but the county next door offered to let Big Box Inc. off the hook for taxes for 25 years. Maybe if you could offer 30-year property tax abatement, the representative suggests, Big Box Inc. might be able to make your town work. You reluctantly agree, and soon discover other city officials agreed to shoulder the cost of needed infrastructure upgrades rather than charge Big Box Inc. the normal impact fees.

A whopping 90% of all state and local development subsidies go to big businesses.

If you think I am spinning a fantastic yarn, just look at the numbers: According to estimates by political scientist Kenneth Thomas of the University of Missouri at St. Louis, U.S. cities and states give out an estimated $65 billion in subsidies each year. To put it another way, that’s enough to employ 1.3 million Americans at $50,000 in combined salary and benefits. Although these subsidies come in various forms—from tax credits to subsidized loans to free infrastructure—the ends are nearly always the same: a whopping 90% of all state and local development subsidies go to big businesses. This is cronyism and it’s happening in cities across the country under the Orwellian guise of economic development.

As the economists Christopher J. Coyne and Lotta Moberg have pointed out, taking from working families and small businesses and transferring it to big business is not only a waste of money—it’s actively making us poorer.

Let’s close out our Big Box Inc. example to understand why. You eventually secured the deal with the fancy representative and your city issues a few million in bonds to fund the road, water, and sewage upgrades. It’s scary, particularly given that your city is already in rough financial shape, but that’s okay because it will all pay off. A shiny new Big Box location opens in your city and everyone is happy. A few chain restaurants and shops come to town to fill out the new infrastructure and you now have a bona fide stroad. A multinational manufacturing company catches word that your town is “pro-business” and arranges to open a facility in your town in exchange for some free land and infrastructure upgrades. Looking at the books, it makes you a little uncomfortable, but that’s okay; everyone loves the giant new roads and shiny new development. Your town’s mayor is praised for “turning the town around” and is even elected to Congress.

The shine quickly starts to wear off. A few local businesses start to struggle since they cannot compete against companies that are exempted from taxes. Downtown is hit the hardest, since the giant new roads required your town to divert money from maintaining existing streets, sidewalks, and public spaces. You raise taxes to keep the schools open and lights on, but many of those businesses you subsidized—a few of whom are your largest employers—are exempt.

The sad reality is that most shortcuts to growth are in fact dead ends. It is ultimately this kind of mentality that helped drive us into the financial crisis.

The added tax burden ends up being the final straw for a few struggling local restaurants and retail establishments, and the tax base shrink even further. A few residents find out about your town’s growing deficits and hightail it out of there in anticipation of future tax increases. Two of your biggest employers—hometown companies that started small and grew into household names—are fed up with the mismanagement, and grants from neighboring states give them an excuse to finally leave. Just before Big Box Inc. is about to start paying taxes, they close up shop and move to a town with an even more generous offer. The stroad development around it soon dries up. The manufacturing facility is also closing down. The reason? They can't convince workers to move to a place with pothole-riddled roads and an abandoned downtown.

It is not hard to see the allure of generous investment subsidies. They bring jobs and investment into struggling communities. They provide what other writers at Strong Towns have called “the illusion of wealth.” But it’s just that: an illusion. The sad reality is that most shortcuts to growth are in fact dead ends. It is ultimately this kind of mentality that helped drive us into the financial crisis.

The Tea Party and Occupy movements were right to raise Cain over cronyism at the federal level. But like economic growth, policy change must start small and build up over time. If we want a healthy economy at the national level, we need thousands of local economies based on gradual, open, and often unpredictable growth. If we want to avoid another Great Recession, a good place to start would be reigning in local cronyism.

(Top photo by Benjamin Child)

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About the author

Nolan Gray is a writer for Market Urbanism. You can follow him on Twitter at @mnolangray.