Tax Cronyism is No Substitute for Good Tax Policy

One of the most significant upsets of the 2014 midterm elections was the choice by Maryland voters to elect a candidate who campaigned on lowering tax burdens and creating a more business-friendly state. Governor-elect Hogan represents a sharp rejection of the heavy-handed regulation and tax-and-spend policies of Governor Martin O’Malley, who raised more than 40 taxes and oversaw an exodus of businesses out of Maryland. It didn’t help that just before the election, a large employer’s announced interstate move shined a spotlight on how state economic policies impact where businesses set up shop and provide valuable jobs. Recently, Bechtel, a Maryland-based global engineering and project management firm, announced it would move its headquarters out of Frederick, Maryland and into Reston, Virginia. It is no secret that Virginia consistently has lower taxes and an overall friendlier business climate than Maryland. In our annual economic competitiveness index, Rich States, Poor States, Virginia ranks 11th while Maryland trails behind at 34th. But this particular case highlights the futile exercise in employing tax cronyism to make up for a hostile economic climate.

Tax cronyism occurs when the government gives a special tax carve-out to a particular business or industry, rather than keeping taxes low and the playing field level for all businesses to compete. This growth-through-economic-planning approach operates in direct contrast to the growth-through-markets approach, which generally allows businesses to compete on a low-tax, level field. The Bechtel move provides an incontrovertible example of how growth-through-markets is the superior approach to foster economic growth and grow jobs.

In 2011, the state of Maryland gave Bechtel a $9.5 million grant to keep its roughly 1,100 jobs in the state through at least 2018. Bechtel has so far received about $4 million, but told state officials it is willing to pay back $3 million of those incentives. Yes, the company is willing to pay $3 million, and forego $5.5 million, to escape the extremely unfriendly economic climate in Maryland and move to the friendlier state of Virginia. The data is overwhelmingly clear that taxes negatively affect economic growth, especially income taxes. The nine states without personal income taxes grew their economies by 62 percent in the last decade, while the nine states with the highest income taxes grew theirs by only 47 percent. In that same time period, the nine no-income tax states grew jobs by an average of 9.9 percent, compared with an average job growth rate of 4.3 percent, less than half, in the nine highest income tax states.

But the lesson here goes one step further. Having an overall uncompetitive business climate cannot simply be offset by implementing tax cronyism. Picking winners and losers through the tax code is not a viable growth strategy. Allowing businesses to freely and fairly compete with lower taxes and less burdensome regulations is a far more effective way to achieve real and lasting economic growth.

Maryland should have already learned this lesson after its budget showdown with “House of Cards.” The Netflix blockbuster filmed its first and second seasons in Maryland, and extracted about $26 million from the state in tax carve-outs to do so. Then, the show’s creators threatened to leave Maryland if the state did not contribute at least $15 million to film the third season. After some media fanfare, the show’s creators and Maryland officials came to an agreement to increase tax carve-outs for the show.

Tax cronyism cannot make up for a poor tax and fiscal policy climate. Creating business and industry carve-outs can be a quick fix in some instances but, as the recent Bechtel move demonstrates, it will never be a better strategy for achieving economic growth than creating a fair and equal playing field with lower taxes and free market policies for all. Apparently voters, tired of the tax cronyism and ever increasing taxes of the O’Malley administration, agreed.

In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth