Time to eliminate the
The InsIder summer 07
Corporate Welfare State
By Stephen Slivinski
What We Believe
T
he federal government spent $92 billion on Business Administration allege that the agency direct and indirect subsidies to businesses provides credit for firms that could not get and private-sector corporate entities—expen- loans in the private capital markets. Research ditures commonly referred to as “corporate on the subject, however, has shown that small welfare”—in fiscal year 2006. Supporters businesses do not face insurmountable obstaof federal subsidies to private industry often cles to finding willing lenders and sources of maintain that government support of busi- credit funding. (See, for example, Veronique ness is in the national interest. For instance, De Rugy’s article “The SBA’s Justification government support is said IOU” in Regulation, Spring to remedy market failure 2007.) The market failure by assisting disadvantaged justification is also used Supporters of government progroups who cannot receive by supporters of programs private funding to establish grams often suggest that corporate geared to funding high-tech new businesses. Supporters subsidy programs are necessary to research, but, as discussed of corporate welfare pro- remedy some sort of market failbelow, the market has not grams also justify business ure. On closer inspection, most of failed to deliver sufficient subsidies as a way to help venture capital to advance those proclaimed market failures maintain the competitiveimportant new technologiness of certain critical indus- simply do not exist. cal discoveries. tries. Yet those justifications Corporate Welfare Prodo not stand up to scrutiny. grams Create an Incestuous There are many reasons why such policies are Relationship Between Business and Governmisguided: ment. In Washington, D.C., industry trade Government Is Ill-Suited to Finding the associations and lobbying firms continually “Next Big Thing.” The function of private pressure lawmakers to give out new business capital markets is to direct investment to subsidies or to protect long-standing handouts. industries and firms that offer the highest That is a natural byproduct of a government potential rate of return. The capital markets, that uses its power to give taxpayer money to in effect, are in the fulltime business of select- favored interests. If there were no possibility ing corporate winners and losers. Yet the that subsidies might be offered, demands for underlying premise of many federal business them would diminish if not disappear. subsidies is that the government can direct the That tendency is nurtured by the problem of limited pool of capital funds just as effectively concentrated benefits and diffuse costs. Subsias, if not better than, markets can. The truth dies are usually given to a few recipients at the is that capital markets are far more agile than expense of many taxpayers. Because there are government and are much better suited to act- such a large number of taxpayers—and each ing on sophisticated market signals than gov- corporate subsidy may cost each taxpayer only ernment ever could be. a few cents or a few dollars—most individual In addition, supporters of government pro- citizens don’t have an interest in lobbying grams often suggest that corporate subsidy against subsidies since the cost of doing so far programs are necessary to remedy some sort outweighs simply paying the taxes. However, of market failure. On closer inspection, most the recipients of those subsidies have a subof those proclaimed market failures simply do stantial interest in making sure they protect not exist. For instance, supporters of the Small the flow of money to them. That leads to a
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Figure 1:
Direct Government Payments to Farmers, 1990–2005
25
20
Billions of Dollars
15
10
5
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Calendar Year
Source: U.S. Department of Agriculture, Economic Research Service, www.usda.gov/data.
great deal of lobbying by special interests but very little lobbying on behalf of taxpayers. In addition, subsidies create a perverse incentive for businesses: If an entrepreneur’s competitors are receiving help from the government, it may appear to be in his or her interest to try to get some of that help, too. That incentive serves only to turn many businesspeople into lobbyists, sidetracking them from their role as entrepreneurs. That, in turn, leads to an overallocation of private resources to pursuing and protecting government subsidies. Corporate Welfare Programs Violate Constitutional Principles. Direct corporate subsidies fall outside the limited enumerated functions of the federal government. Nowhere in the
The InsIder summer 07
Constitution is Congress granted the authority to spend funds to subsidize industry directly, or to enter into joint ventures with automobile companies, or to guarantee loans to favored business owners. Yet, since the New Deal, by applying very expansive readings of the General Welfare Clause, the Supreme Court has allowed Congress to redistribute wealth from taxpayers to favored business interests. CASe STudIeS Agribusiness. The biggest direct subsidy program in the federal budget is crop and farm subsidies. In fiscal year 2006, taxpayers footed the bill for $21 billion in agricultural subsidies. Eleven years ago, Congress voted to phase down farm subsidies through 2001. Instead,
the opposite has occurred: A series of so-called final nail in the coffin of the Freedom to Farm emergency spending bills and the resurrection Act’s commitment to weaning farmers from of a price support program in 2002 have since taxpayer support. Instead of zeroing out farm hiked subsidy levels to near-record highs. subsidies, the legislation created a new version Figure 1 shows the trend of farm subsidy of the old price support program that was estipayments between 1990 and 2005. The years mated to cost taxpayers $99 billion in direct in which farm subsidies were the lowest (1994 subsidies over six years. The four fiscal years through 1997) correspond with two key events: since the enactment of the 2002 farm bill have (1) a rise in commodity prices already seen an estimated and (2) the passage of the $72.9 billion spent on farm Federal Agriculture Improvesubsidies. The United States has prospered ment and Reform Act of Although members of 1996, often referred to as the even while the farm sector has Congress from farm states Freedom to Farm Act. Subsi- shrunk as a percentage of the have an interest in continudy levels before 1996 were set overall economy. Over the past ing to subsidize farmers, the by a formula that triggered 50 years, the number of people United States has prospered an increase in farm subsidies even while the farm sector working and living on farms has when crop prices fell. Starting has shrunk as a percentin 1995, crop prices began to dropped. age of the overall economy. rise, thereby allowing subsidy Over the past 50 years, the levels to drop. number of people workThe Freedom to Farm Act, passed in 1996 ing and living on farms has dropped. Farm when commodity prices were high and demand employment— including farm proprietors as for subsidies was low, ended the price support well as wage and salary workers—makes up program and replaced it with a declining fixed less than 2 percent of total employment in the payment unrelated to market prices. Farm United States. The percentage of Americans subsidies were scheduled to decline from $5.6 who live on farms dropped from 16.6 percent billion in 1996 to $4 billion by 2002. After in 1948 to around 2 percent in just over 40 that, crop subsidies were set to disappear. years. Yet thanks to technological advances, The scheduled phaseout remained intact farm productivity is at a historically high for about two years until Congress reversed level. course in 1998. When crop prices began to Despite what some farm-state politicians decline that year, Congress passed a large might say, farms do not need to compose a “emergency” supplemental appropriation that substantial portion of the economy for the hiked total farm subsidies to $12.4 billion. United States to remain economically strong. Subsequent supplemental legislation spurred A smaller farm sector is not a sign of economic farm subsidies to new heights, amounting to a decline. Quite the contrary: A farm sector that total of over $79.5 billion between 1999 and can produce substantial amounts of food with 2002. That’s $60 billion more than the Free- less capital and fewer workers is a testament dom to Farm Act’s phaseout of crop subsidies to economic progress. would have allowed if subsidies had been cut However, the conventional wisdom continas promised. ues to view federal agricultural programs as In May 2002, President Bush signed into vital to preserving impoverished and belealaw a new six-year appropriation that put the guered family farms in the United States. The
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reality is quite different from Innovative Research prothe popular notions about gram show why governAverage income for farm housefarming in America today. ment is ill-suited to discover Most farmers are relatively holds has exceeded the national and fund the technological average by 5 percent to 17 percent advances that fuel the highwealthy. Average income for farm households has every year since 1996. tech economy. exceeded the national averThe ATP was created in age by 5 percent to 17 per1988 to support technologicent every year since 1996. By contrast, when cal research that had the potential to provide large-scale federal farm subsidies began in the broad-based economic benefits for the nation. 1930s, farmers’ incomes were only half the The presumption was that the program, part national average. As the Department of Agri- of the Commerce Department’s National Insticulture itself reports, “Farm households have tute of Standards and Technology, would give higher incomes, greater wealth, and lower a boost to technologies that were “pre-competconsumption expenditures than do other U.S. itive” or “high risk” and could not get funding households.” on their own in private capital markets. Since Most farmers don’t receive direct subsidies its inception, the program has funded more from the federal government. The taxpayer- than 768 projects at a cost of at least $2.3 bilfinanced handouts go to only about one-third lion in federal matching funds. of the nation’s farmers and ranchers. So where Program supporters suggest that ATP is a does all the taxpayer money spent on farmers funder of last resort for high-tech businesses. actually go? Mainly to large corporate agri- However, a study by the General Accounting businesses and the richest farmers. In 2005, Office (now the Government Accountability the most recent year for which comprehensive Office) found that 63 percent of the compastatistics are available, the richest 10 percent nies that applied for ATP grants didn’t look for of all subsidy recipients received 66 percent of private capital or other sources of investment all subsidies. before they applied for government money. There are a variety of reasons to terminate That raises some serious questions: Are the farm subsidies. There are, however, no defensi- projects that the government funds examples ble reasons to continue them. These programs of promising but overlooked entrepreneurial exist today mainly as a way for politicians to initiatives? Or are they mostly examples of shower taxpayer money on powerful interest how savvy businesses can get the federal govgroups. ernment to underwrite their products’ R&D? High-Tech Companies. The Advanced The evidence seems to indicate the latter. Technology Program and the Small Business A recent GAO study points out that some
The InsIder summer 07
of the biggest ATP expenditures went to tive Research program indicates. The SBIR is research ventures that were already gener- a less high-profile program than ATP, but its ously supported by the private sector. For budget is actually much larger—about $1 bilinstance, the ATP spent $1.2 million in the lion—because it consists of portions of many early 1990s to develop a system to recognize federal agency research budgets. cursive handwriting for pen-based computer Created in 1982, the SBIR’s goal is to inputs, such as those used in handheld devic- stimulate technological innovation. Instead, es today. In fact, this line of research had the result has been a crowding out of pribegun in the private secvate research spending by tor during the late 1950s, firms receiving government and patents for workable money. According to regresIn addition to being duplicative, versions of the technolsion analysis done by Scott ogy were issued five years government funding of research J. Wallsten, for every dollar often ends up simply underwritbefore the start of the ATPof SBIR grant money the funded project. Companies ing other aspects of corporate average company receives, like Apple Computers and operations, as a study of the Small it reduces its own R&D by Motorola were already well a dollar (see “The R&D Business Innovative Research on their way to coming to Boondoggle,” Regulation, market with versions of this program indicates. 23, Winter 2000, pp. 14– technology. Other technolo15). That forgone dollar of gies that were already well R&D money does not disfunded and researched by the private sec- appear. It goes to fund another aspect of the tor were methods to expand the capacity of firm’s operations. The consequence is that, fiber optic cables and technology to regener- instead of contributing to an overall increase ate human tissue and organs. The ATP spent in R&D spending, the federal government roughly $2 million to duplicate funding for finds itself underwriting the profit margins of R&D in those technologies. There is obvi- small businesses and corporations. ously no market failure here. These supposexporters. The mission statement of the edly precompetitive technologies were able Export-Import Bank stipulates that the bank’s to attract substantial funding in the private main purpose is to finance the purchase of sector. U.S. goods in foreign markets. The justifiATP grants have gone to some of the big- cation it provides for its fiscal 2008 budget gest companies in America or their subsidiar- request is more transparent and perhaps more ies—companies that have no trouble funding honest: “to sustain U.S. jobs by financing U.S. their own R&D. Over the last 12 years, many exports.” The Ex-Im Bank does that by using Fortune 500 companies or their subsidiaries taxpayer money to subsidize loans to foreign have received millions of dollars of ATP fund- purchasers of U.S. products and to provide ing. Top beneficiaries of ATP grants over the loans and loan guarantees to U.S. compapast 15 years include IBM, General Electric, nies seeking to enter export markets. It also Honeywell, Xerox, and Dow Chemical. provides insurance for companies investing In addition to being duplicative, govern- overseas. ment funding of research often ends up simply The loans and guarantees that the Ex-Im underwriting other aspects of corporate opera- Bank grants to U.S. companies qualify it as the tions, as a study of the Small Business Innova- underwriter of the sales of some of the biggest
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Fortune 500 companies, none probably because those projof which would have trouble ects simply weren’t ones that Any attempt to terminate business getting funding for worthinvestors found worthwhile, while overseas projects. Boe- subsidy programs will require alter- or because the interest rates ing is the largest corporate ing the incentives of legislators. on those loans were higher beneficiary of Ex-Im Bank than the companies were loan activity, leading many willing to accept. That is not commentators to refer to the Ex-Im Bank as an example of market failure—it is a testament “Boeing’s Bank.” to how well private capital markets work. Supporters of the Ex-Im Bank suggest that government credit is needed to level the play- HoW To elImINATe THe CoRPoRATe ing field for U.S. companies as they compete WelFARe STATe against foreign companies that receive support Any attempt to terminate business subsidy from their governments. Yet the Ex-Im Bank’s programs will require altering the incentives most recent annual Competitiveness Report of legislators. Individual members of Congress points out that fewer than one-third of all its lack the incentive to discipline themselves. If loans and guarantees go to counter subsidized they were successful in saving taxpayer money foreign competition. by defunding a particular program, less absteInstead, most of the Ex-Im Bank’s loan and mious members might be able to use that guarantee portfolio is geared toward providing money to bolster the budget of another favored credit for overseas projects and purchases that program. Also, member A knows that voting the bank says could not receive private fund- for a decrease in member B’s favored program ing. However, 99 percent of capital-intensive might result in future reprisals. For those reaprojects in developed countries are already sons, attempts to defund these programs one financed by private borrowers. The amount by one, or in small groups, during the annual for developing countries is 89.7 percent. The appropriations process are not likely to yield Ex-Im Bank provides a mere 2 percent of the results. An institutional problem of this sort financing for projects in developing countries. requires an institutional solution. Those data do not provide good evidence One way out of this dilemma might be that there is a failure in the credit markets. Pri- a corporate welfare reform commission vate capital markets have been able to provide (CWRC). General guidelines for a bill creatvirtually all of the funding for overseas proj- ing a CWRC could be as follows: ects and acquisitions of U.S. products. If the • The commission would not be composed projects the Ex-Im Bank underwrites were not of sitting members of Congress. It would be able to receive funding in private markets, it’s chosen by bipartisan agreement between the
The InsIder summer 07
President and the leadership of both houses of general understanding that even though the Congress. military base structure then made little sense • The commission would convene for the on the whole, Congress could not bring itself purpose of proposing a list of corporate wel- to close specific bases. According to Kenneth fare programs that should be eliminated. R. Mayer, during the 10 years before BRAC, • The commission would address only “Congress prohibited studies of whether bases spending programs, not tax preferences in the should be closed, required an environmenbudget, and no corporate welfare spending tal impact statement for any proposed cloprograms should be considsure, and attached riders to ered “off the table.” appropriations bills to bar • The commission’s list of the spending of funds to Sunlight is the best disinfectant. recommended program terclose particular bases,” (see minations would be voted on A corporate welfare commission “The Limits of Deregulawould finally allow scrutiny of by both houses of Congress, tion: The Rise and Fall of with no amendments, within those programs in a coordinated BRAC,” Regulation, Fall 60 days of the commission’s public proceeding. That’s not 1999). Although many final report. members of Congress liked something that happens regularly A commission structured the idea of closing military along those lines would solve in Congress today. bases in the abstract, they two main problems: were rarely willing to vote • The special interests for a bill that would close dilemma: Because the members of the commis- a base in their district. Congress was unable, sion would not be incumbent lawmakers, they because of institutional and political biases, to would be far more insulated from political con- downsize the defense budget at a time when cerns. While there would still be special interest doing so was often cited by members of both pressure on the members of the commission, parties as an important goal. that pressure is likely to be much less effective. A final reason to convene such a commis• The collective choice dilemma: Because sion is that sunlight is the best disinfectant. A every program would be terminated by an up- corporate welfare commission would finally or-down vote on an unamendable bill, there allow scrutiny of those programs in a coordiwould be no vote trading on the specifics of the nated public proceeding. That’s not something bill as there is during the normal appropriations that happens regularly in Congress today, and process. The commission would have the abil- it’s long past time for sustained public attention ity to cast a wide net and create a list of pro- to a debate on the merits of the federal governgrams that would hit a larger number of special ment’s role in subsidizing private companies. interest constituencies than any one member of, or group within, Congress would propose. To Mr. Slivinksi is Director of Budget Studies at further enhance the possibility of success, the the Cato Institute. This article is adapted, with commission could present its list of program permission, from his longer paper “The Corterminations to Congress in a nonelection year. porate Welfare State: How the Federal GovThe CWRC has an ancestor in the Base ernment Subsidizes U.S. Businesses,” Cato Realignment and Closure Commission. The Institute Policy Analysis No. 592, May 14, BRAC was created after the collapse of the 2007, available at www.cato.org/pubs/pas/ Soviet Union, at a time when there was a pa592.pdf.
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