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One of the major problems with communities doling out tax breaks and other favors to large corporations is that doing so disadvantages their own, local, usually smaller, businesses. After all, those monetary favors lower costs and offer subsidies for the big guys, making it easier for them to “compete” against smaller entities that don’t receive public largesse.

Common sense would dictate this shouldn’t happen much– what savvy politician would deliberately sabotage a local business? But we all know that these giveaways happen all too often. So what could the motive be? Here’s a thought for you: they build political capital for the politicians doling them out with the less than fully informed voting public.

Here’s how it works. The pols who negotiate the deals get to stand next to some big-name corporate executive and extol the virtues of their actions, pointing to the jobs they supposedly created and the economic activity they initiated. They get their face on local news and in the paper, and, at the same time, they send out glowing tweets and Facebook posts. But the public is rarely informed about the collateral damages so, instead of getting punished at the polls for their economic sabotage, voters reward them for it.

In a fascinating new paper published in the most recent issue of the Strategic Management Journal Manav Raj of the Stern School of Business at New York University ties all of these strands together, and shows how they work together, to disadvantage smaller, more local business, while increasing the power and profits of the corporate behemoths they receive the state’s fiscal generosity.

Raj found that states with more competitive legislatures hand out more corporate largesse, and then see more small businesses fail to succeed against larger, incumbent firms. As Raj explained in the paper (and many thanks to him for sharing a copy with me), “When legislative competition is high, well-connected incumbent firms are better able to leverage familiarity, access, and influence to take advantage of this opportunity and transform the institutional environment. Policy rewards to well-connected incumbent firms may have negative consequences for younger, less-connected firms and implications for the entrepreneurial environment.”

Essentially, more politicking is better for big corporations seeking handouts and worse for new businesses trying to make inroads against dominant competitors. Here’s Raj’s chart on how this effect can be seen broadly across legislatures.

Prior academic work has shown that corporate handouts help politicians with their re-election campaigns. Nate Jensen and Ed Malesky, for instance, found that voters reward incumbent pols who negotiate more corporate giveaways, even as those giveaways increase inequality; Cailin Slattery and Owen Zidar found that the use of incentives pops when a governor is up for re-election, suggesting a connection between handouts and re-election hopes.

As a result, it makes sense that high levels of legislative competition — meaning tiny majorities for the party in power, and a higher likelihood that a legislative chamber can flip from one party to another — make handouts to incumbent, dominant firms more likely. In those instances, legislators on the margins need more political capital to win re-election and have more power to extract concessions during legislative debates because their votes are more valuable. 

Why are their votes more valuable? Well, when a majority is tiny — like in the U.S. Senate at the moment — each member has the power to put their vote up for sale in a way that lawmakers who are part of a massive majority can’t, since in the latter situation the party in power can afford to lose votes and still enact its agenda. To continue with the U.S. Senate as an example, because Democrats need Sen. Joe Manchin’s vote on everything they want to pass, he becomes, only somewhat jokingly, President Manchin. And, of course, business interests know the situation in a particular legislature, and make the most of it. 

Raj also found corporate handouts increase alongside increases in political donations by businesses, creating a toxic stew of back-scratching that entrenches those corporations that play politics best, even if they don’t provide the best service to customers or do very much in the way of innovating. It makes more sense for them to spend money on political campaigns and lobbying shops than R&D.

All of this is bad for small firms. They already have an array of obstacles placed before them without having to worry about their larger competitors getting the government to cover a percentage of their operational costs. And indeed, Raj found that states that hand out more incentives see more new business fail to launch. 

As he wrote, “The findings indicate that increased legislative competition creates an institutional environment that favors entrenched incumbents over younger firms, and thereby increases young firm mortality.” New businesses just can’t keep up with the political power of entrenched incumbents.

Raj’s important findings add to the evidence showing that the corporate giveaway issue is a political problem, not an economic one. Elected officials are using incentives to juice their vote totals, not local economies. 

Of course, you could read his study as a case for one-party rule: Less competition, fewer corporate handouts, more small business success. Viola! But that’s not really what I’m going for here.

What’s needed is to flip the current political incentive structure on its head, making it more politically valuable to disavow handouts than to take them — or finding ways for more responsible leaders to join together to eliminate incentives without any one person having to pay the political price. That’s the motivation behind the interstate compact against corporate giveaways, for instance.

As Raj’s study makes clear, doing so is not only about preventing the waste of taxpayer money, but ensuring that small, local firms have a chance to get off the ground and thrive.

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Pat Garofalo is the author of The Billionaire Boondoggle: How Our Politicians Let Corporations and Bigwigs Steal Our Money and Jobs, the Boondoggle newsletter, and the director of state and local policy at the American Economic Liberties Project.

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