Strong Fundamentals Are Better Than Tax Bribes

The District of Columbia is poised to put together a $32.5 million tax incentive package to keep LivingSocial located in the District, an excellent example of a good idea that’s in many ways a terrible idea and most of all highlights serious underlying problems.

What’s good about it? Well the basic thinking is sound. Businesses exist on a spectrum of their scope of operations. A dry cleaning shop probably only serves a small neighborhood whereas Microsoft is a global business services and software vendor. All cities have locally serving businesses, but the degree of wide-scope firms that exist in any given city varies quite a bit and the presence of broad-scope firms in your city can be broadly beneficial. One way to think about this is that productivity tends to be higher in broader-scope firms so you get higher wage jobs. LivingSocial is a firm with a global set of operations, so D.C. gains some real dividends from its presence that are more significant than direct tax revenue.

On the other hand, these kind of deals stink. Any metropolitan area is home to a number of different municipalities. When those municipalities all start competing against one another to offer special tax breaks to companies that threaten to move around, the result is an overall loss of revenue and tax code efficiency. What’s more, precisely because it’s a bidding dynamic you’re likely to end up in a “winner’s curse” situation where only municipalities who are badly overestimating the value of any given firm wind up winning the auctions. Last, when cities get in the business of handing out ad hoc tax incentives like this the door is open wide to all kinds of corruption and malfeasance.

The moral I wish the city council would learn from this is that the benefits to improving the fundamentals in D.C. would be large.

For example, suppose the city were able to reduce the cost of locating in D.C. to all businesses by allowing for denser development of the downtown central business district? Virtually all modern cities feature buildings taller than the 130-foot structures that dominate downtown Washington, D.C. If we were to join them in building skyscrapers then rents would fall and it would make more sense for firms that aren’t hyper-specialized in government-related industries to locate here. It would be one thing if the city government just wasn’t interested in that as a policy goal. But we can see here that they are interested, interested to the tune of $32.5 million in tax incentives. But not only would taller buildings mean lower rents for everyone, they’d also mean more tax revenue, which would allow for lower rates and better public services for everyone.