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John Hood's Syndicated Weekly Column

First Shoe Drops on Incentives

Sep. 10th, 2004
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RALEIGH – Being somewhat of a devotee of word and phrase origins, I decided to look up the source of the phrase “waiting for the other shoe to drop.”

It seems that long ago a traveler came in late to a hotel and, while undressing, dropped his first shoe rather loudly on the floor. Remembering that the partitions were thin and many others were sleeping, the traveler removed his other shoe and carefully placed it on the floor. He then finished undressing and got into bed. Just as he was drifting off to sleep, a shout came from the man in the room below: “Well, drop the other one then! I can’t sleep, waiting for you to drop the other shoe!”

What prompted me to research the phrase was the rather-stunning news on Sept. 2 that a federal appeals court had struck down the state of Ohio’s tax-credit system of incentives for economic development. Overturning a lower-court ruling, the three-judge appeals panel found that $280 million worth of tax credits given to automaker DaimlerChrysler violated the U.S. Constitution’s interstate commerce clause, which gives Congress sole authority to regulate interstate commerce and precludes state or local action that creates the equivalent of trade barriers.

Likening the case to previous decisions by the U.S. Supreme Court, the panel determined that Ohio’s investment tax credit “is to encourage further investment in-state at the expense of development in other states, and the result is to hinder free trade among the states.” The appeals panel did not strike down another tax incentive offered to DaimlerChrysler, a property-tax exemption.

North Carolina does not lie in the same circuit as Ohio does, so the decision is not legally binding here. But it does have significant long-term implications for how economic development is practiced in our state – and ought to be at the forefront of the political debate this year about state tax and spending policies.

I’ve long argued against differential tax rates based on where companies locate or what kind of business they do. I think these kinds of incentives are bad for the economy, because they interfere with free enterprise and cause distortions in the investment of labor and capital, and because they violate state constitutional requirements that taxing authority be exercised in a “just and equitable manner” and only for a true “public purpose.”

Frequently, the response I’ve gotten from economic developers, lobbyists and politicians goes like this: “John, I agree with you in principle, but if every other community is offering incentives, we can’t afford not to play the game.”

Federal judicial action invalidates this excuse. If we can set a clear precedent that states must treat every company earning income in their jurisdiction the same for tax purposes – regardless of where their headquarters is, who their lobbyist is, or whether they jump through some politician’s hoops – then the rules of the game will have changed. I look forward to a groundswell of excitement from North Carolina’s political establishment, from legislators and chambers of commerce and committees of 100 enthusiastically embracing the court decision in the Midwest and volunteering to serve as plaintiffs for a similar challenge in the Southeast.

Do I hear crickets?

Speaking of hearing, let me explain the dropped-shoe reference. You see, the taxpayer victory over DaimlerChrysler in Ohio was the loud first shoe. Currently, many political insiders across the state are waiting nervously, tossing and turning in their respective beds, for a new challenge to incentives in North Carolina state courts. Just the other day, I read in the Forest City Daily Courier about a meeting of some antsy economic developers there. “Everybody in industrial development knows there is a lawsuit coming though we don't know when, where or how,” one said.

That other shoe hasn’t dropped yet. It seems to me that, in the interest of a more restful night’s sleep, the various interested parties might want to embrace the possibility of challenging the most egregious programs – such as the William S. Lee tax credits that according to the state’s own studies are responsible virtually no new net jobs – in a federal court.

The argument is not, of course, that states cannot act to make their business climates more attractive. The argument is that they must employ constitutional means to do so, using tax rates and infrastructure available equally to all citizens and businesses. This argument already has precedent in North Carolina; it was the reason why federal courts struck down our discriminatory tax on intangible assets years ago.

Let’s not wait for the other shoe to drop, okay?

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Hood is president of the John Locke Foundation, publisher of Carolina Journal.com, and host of the statewide program “Carolina Journal Radio.”