State Tax Incentives for Business: Healthy Competition or "Race to the Bottom"?

May 2, 2005

Unedited transcript prepared from a tape recording.

Proceedings:
MR. GREVE:  Today's topic is I have to say near and dear to my heart, esoteric though it may seem at first sight, state competitionism, anyway, is the genius of American federalism.  We think it's good that states ought to compete for productive citizens, for productive businesses.  But the question, of course, is how there are many ways to compete some of them are extremely destructive like tariffs.  Other forms are we believe quite sensible and productive.  So the question you have to ask yourself is, What are the rules of the game that make state competition productive rather than destructive?

Historically the answer has been at least within the constitutional framework, we try to settle for a few basic rules.  One of them is free entry and exit into each state.  The other rule is the general norm of nondiscrimination which is embodied in several constitutional provisions, and in one important inference from the constitutional structure, the Dormant Commerce Clause.

It's never been quite clear how these rules are supposed to operate on the margins and in any given context.  One of the most recent contexts in which this has arisen is of course the question of taxes and state incentives and state tax abatements for businesses that choose or agree to locate within any given state's boundaries.

I think one of the reasons why that is such a central focus of the debate is that once upon a time in the United States, states competed on a whole ton of margins from environmental standards, labor standards and so forth.  There is, of course, still a lot of that going on, but on the other hand, there are in many, many areas pervasive federal minimum standards that choke off competition for states that would want to cooperate on those margins.

What then happens is states or jurisdictions start cashing out, so to speak, or monetizing the competition that once upon a time took place on other margins.  Some of you may remember this, years ago when interest rates were regulated in the United States for banks, banks gave away toaster ovens.  Tax incentives or selective tax abatements are kind of the toaster ovens of interstate tax competition.  The question you have to ask yourself is, Obviously, that form of competition is not as good as the competition  on the margins that have been replaced here?  But you nonetheless still have to ask yourself, Is it better than nothing or should we think about some other rules of the game here?

The latest focal point of this debate has been the Cuno v. DaimlerChrysler case from the Sixth Circuit in which the Sixth Circuit Court of Appeals sustained some tax incentives and barred others as prohibited by the Dormant Commerce Clause.  Both sides in that case I understand have filed, one side already has filed, for cert. with the Supreme Court.  The other side is planning to file.  They've got an extension.  Meanwhile, there are some voices to demand congressional intervention in this area.

We have a terrific band of experts to discuss all this this morning.  We'll have the first panel which I'll moderate on the Cuno case and cases like this that are bubbling elsewhere in the country.  That will deal mostly with the intricate legal questions here.  And then the second question will address some of the political and economic questions in this area.

For the first panel we're proud and grateful to have Peter Enrich who has handled some of these cases and written about them.  He'll go first and then we'll turn to Brannon Denning.  Each speaker will go for about 15 to 20 minutes.  Then we'll have a little exchange and open it up for questions.

MR. ENRICH:  Good morning.  It's a pleasure to be here.  I think that Michael has framed the question exactly right.  This really is an issue of what the Constitution can say about when competition among the states is beneficial and effective and when it is destructive and prohibited.

Before I dive into the constitutional law on the issue, I think it's important though to back up a little bit and think about the dynamics of tax incentives both from an economic and a political perspective because I think it's only in that setting that we can begin to really understand how and why the constitutional constraints should apply here.  I ask your indulgence and let me back up a little bit and then we'll get to the law in a few minutes.

Let me start with the example that the Cuno case involves.  Back in 1998, Chrysler Corporation wanted to build a new Jeep assembly plant to replace its existing Jeep assembly plant in Toledo, Ohio.  This was going to be a $1.2 billion plant.  It was going to employ about 5,000 workers, largely the work force that was already employed by Chrysler in Toledo.

They pretty quickly let it be known that they had narrowed their site selection down to two locations, one in Toledo not far from the existing site, the other not too many miles down the road across the Michigan state line where they'd still be able to use pretty much the same set of suppliers, probably much of the same work force, but would be in a different state.

That put them in a position to turn to the states of Ohio and Michigan and to the city of Toledo and say, What will you do for it?  By the time the bidding ended, Toledo and Ohio had put together a package of incentives that added up to about $300 million for this $1.2 billion plant that was going to continue to employ the same work force in any case and use the same suppliers in any case.

A large part of that package of incentives involved a whole bunch of things.  It included assembling the site and excusing some environmental constraints on the site and the like, but the vast bulk of it was two tax breaks.  The one was Ohio's investment tax credit which allowed businesses locating at sites like this one to reduce their corporate income tax by 13-1/2 cents for every dollar of new machinery and equipment that they placed in use at the site.

The other was a 10-year exemption from all property taxes on personal property associated with the plant, conditioned on the employer agreeing to meet certain levels of overall investment and certain levels of employment at the facility.

This is how business is done in America today.  When large businesses are ready to locate a facility, they turn to the states and localities where they're interested in locating often after they've already made a decision about where they're going to locate, but they play their cards carefully and they extract very large incentive packages.  For a company to locate a major facility somewhere without doing that would frankly be irresponsible in the present environment.

What are the effects of this new way of doing business?  There are a couple that I think are quite obvious.  The first one that's quite obvious is that there has been a real transformation in who pays state and local taxes in America.  Exact numbers are hard to come by, but back in 1997, one economist did a pretty good study trying to determine the magnitude of these incentives nationally and he came up with a figure of about $50 billion nationally in 1997.  The competition has continued to accelerate in the years since then.  The number today would clearly be far higher than that.  It's a big number.

The impact of that number is what is interesting to me.  We've seen a real shift in who pays the costs of state and local government.  The Advisory Commission on Intergovernmental Relations used to keep track of a lot of statistics of who paid which taxes.  An analysis that was done of their work in the mid-1990s showed that back in 1950, approximately half of state taxes were paid by businesses.  By 1990, and again, I don't want to argue about whether they've got the analysis exactly right, but using the same analysis from 1950 to 1990, by 1990, the percentage had dropped from 50 percent to 25 percent.

In 1994, the Advisory Commission was defunded and so we no longer have statistics to keep tracking that more recently, but, again, the trends have clearly accelerated and all the studies that have looked tax by tax have shown that in the property tax, in the income tax, we are seeing a continuation of that same shift.

What's happening is we're moving from a system where businesses were major taxpayers to a situation in which they are much smaller contributors.  Who is picking this up?  It's being picked up largely by heavier tax burdens on individuals.  I would suggest also heavier tax burdens on small businesses who aren't in a position to play this game.

That shift isn't all because of tax incentives.  It's partly because of much more aggressive tax planning, because of new tax planning opportunities that have been opened up, but a very substantial piece of it the analysis suggests is due to the proliferation of tax incentives geared at business location.  That's a significant change in the landscape.

The second thing that I think is clear is that what state are doing is turning more and more toward an ad hoc, case-by-case, politically driven kind of industrial policy.  They are trying to pick winners by industry.  They're often trying to pick winners by company.  They are doing it in an environment that is heavily influenced by highly paid advocates on behalf of large businesses.  And, again, the people who are getting the benefits of this are a relatively small set of relatively large businesses who are becoming very adept at playing a very political game.

The result is a tax regime at the state level that has become extremely complex and open to tremendous variation from company to company between different types of businesses.  The Tax Foundation recently did a piece in which they talked about what good state economic policy should look like, and they said taxes should aim to raise revenue with a minimum of economic distortion and should not attempt to micromanage the economy.  What we're seeing is a trend that pushes us exactly in the opposite direction.  So those that I think are clear.

There's a third thing that is far less clear:  Do these incentives really help states compete for business?  Over the 30 or 40 years that these incentives have been proliferating like mad, economists have been having a field day studying them and asking what difference do they make, what impact, to what extent do state and local tax burdens affect business location, to what extent do tax breaks influence business location decisions?  The evidence from those studies is pretty clear.  The evidence is that at best these tax incentives have a marginal effect on business location.  The empirical evidence is just absolutely overwhelming on this, they don't have a significant effect on business location decisions.

That may seem a little counterintuitive, but I think when you think about it for a minute, it's clear why that is, and there really are three reasons.  First, state and local taxes are just too small.  They aren't a major cost driver for businesses.  One recent study using IRS data calculated that the average business, about slightly over 1 percent of its costs are state and local taxes.  Again, there is some dispute about this.

COST who will be speaking a little later today has done a different analysis.  If you use their numbers, it may come out looking more like 1-1/2 percent, but it's still a very small piece of a business cost structure.  It's swamped by things like how much you're paying for your labor, how well trained your labor is, how much it costs you to get utilities, what's your access to markets, what's your access to needed supplies, what's the level of environmental regulation.  You can go down a very long list of other factors that vary from state to state that are much, much larger considerations.  So that's the first reason that tax breaks have only a very small effect.

The second reason is everyone is playing the game.  You may get a slightly different tax package from Michigan than you got from Ohio, but you're getting a tax package from each of them and they're going to be competitive with one another.  So that's going to reduce the marginal impact of what anyone is doing because they're all doing it.

Third, states unlike the federal government have to operate with balanced budgets.  When they reduce taxes, they have less revenue and they provide fewer services.  The econometric analysis of the impact of services on business location are somewhat different from the econometric analysis of the impact of taxes.  If you cut expenditures on education, on infrastructure, on public safety, you become a less-attractive location for business.  As states are reducing their revenues to provide tax incentives, they are also reducing services, and there's an offsetting negative effect that counterbalances some of whatever small effect there was.  So in any case, put those things all together and the econometric evidence is pretty clear, these are not the big driver of business location that some would like to suggest that they are.

You might think then that the answer is the politicians will figure this out and they will stop playing the game.  But if you think about it for a moment, you'll realize that that's not the way that this kind of situation works.  We have a situation where each state is unable to be the first one to say no partly because they actually believe that these things make a difference, but even if they know, and you often talk to state legislators who understand perfectly well that these aren't the real drivers of business location, and they still say I can't vote against these things.  I have to politically look like I'm doing whatever I can to compete for the good of our state's economy.  So states are stuck in this battle.  It's a classic prisoner's dilemma where no one can be the first one to, as they say, unilaterally disarm.

If we had more time we could talk about some of the other ways that in a federal system something like that might be controlled, but let me jump to the one that brings us here today.

The Constitution comes to the rescue at this point.  This is a place where we have been before.  In fact, probably the primary reason for the convening of the Constitutional Convention was that the states under the Articles of Confederation had gotten into a very similar kind of situation where they were each competing to get the benefits of large-scale economic activity in their own states and competing in ways that were both raising levels of tension and friction between the states, but also undermining the ability of a national economy to evolve in rational ways.

What was the solution?  The Constitution.  The Constitution primarily through the Commerce Clause said regulation of interstate commerce belongs not to the states but to the federal government.  Those of you who have looked at the Constitution recently will remember that really all the Constitution says on the subject is that Congress shall have the power to regulate commerce among the several states.  But since the very earliest years of constitutional interpretation, it's been understood that the implicit message of that provision was, and the states shall not have the power to regulate interstate commerce, at least not in ways that interfere with the free flow of economic activity among the states.

How does that apply here?  In the area of state taxation, the courts have developed a number of guidelines, and the one that has been the most consistent over the years has been that states cannot use their tax systems, nor their regulatory systems for that matter, but they can't use their tax systems in ways that discriminate between out-of-state economic activity and in-state economic activity and that favor in-state economic activity over out-of-state or interstate activity.

Consider the investment tax credit that Ohio granted to DaimlerChrysler.  What does it say?  It says, you're already a taxpayer in Ohio and you're going to be a taxpayer in Ohio because you're selling cars in Ohio.  If you locate new plant and equipment in Ohio, then you'll be able to reduce your Ohio income tax.  However, locate exactly the same plant and equipment across the border in Michigan and you get no reduction in your Ohio tax.  Two identically situated businesses each of whom does business in Ohio, each of whom pays tax in Ohio, one of which locates a new facility in Ohio, the other of which locates a new facility in Michigan, are going to be treated dramatically differently in their taxation by Ohio.  The one is going to pay a lower tax because of its decision to locate new activity in the state.

That is discrimination in factor of in-state economic activity.  It fits within a long, long line of Supreme Court cases so holding and that's the claim that we made in the Cuno case and it's the claim that the Sixth Circuit sustained.

Let's develop this issue a little bit further and think about that property tax abatement, the other provision that Ohio used to lure DaimlerChrysler.  The first thing that I think you have to be very clear about is no one would suggest that it would be discrimination for a state to say we're not going to business/personal property.  Many states don't.  No discrimination because we're not taxing business personal/property that's located in Ohio, we're not taxing business personal/property that's located in Michigan, we're not taxing any business personal/property.  That's not discriminatory.  Likewise, to say we're going to lower our tax rate.  There's nothing discriminatory about that.  It treats everyone equally.

That's not what Ohio did.  Ohio said you only get this property tax exemption if you commit that you're going to locate a specified number of employees and a specified level of investment over and above the investment that's going to be exempted from tax in the state.  If you do that, then you pay no property tax, no personal property tax.  If you don't locate or don't commit to locate as many workers and as much investment here, then you're going to pay personal property tax.  They're essentially using the offer of a personal property tax reduction as a way to coerce the business into making other commitments to economic activity in Ohio.

We argued that that made this discriminatory.  The Sixth Circuit held that although some conditions of that sort attached to reductions or abatements in property tax would be unconstitutional as they had to, the Supreme Court and some other federal courts have so held.  They said some such conditions would make a tax break unconstitutional, but these particular ones in this particular situation were not coercive enough to render it unconstitutional.

As Michael mentioned at the beginning, we're now at the stage of appealing these rulings to the Supreme Court.  We applied a petition for cert. to the Court a couple of weeks ago asking the Supreme Court to review the Sixth Circuit's finding concerning the property tax portion.  The defendants have made crystal clear that they are going to file petitions for review of the decision regarding the investment tax credit.  Their briefs are now due in mid-June, so we anticipate that the Supreme Court will decide probably in the beginning of their fall term whether or not they want to hear this case.  I'm not in a position to make any kind of predictions on that.

Meanwhile, a couple of other developments should be just very briefly mentioned.  First, in the wake of the Cuno decision, a number of other cases are beginning to spring up challenging state tax incentives in other states.  There is a case now pending in Nebraska.  There is a case now pending in Minnesota, the attorney for which is going to speak on the next panel.  There is certainly going to be litigation over the next few months in a number of other states, probably including North Carolina and a number of others, so we're going to see more and more litigation in this area.

The second development is that in the wake of the Sixth Circuit decision, Ohio's Senator filed legislation in Congress that essentially would have reversed the decision.  That was in the last session of Congress.  It died unacted on.  We expect that there will be similar legislation filed sometime in the near future in the current session, and, again, there will probably be more talk about that on the second panel.

Let me close by reemphasizing one critical point that comes to Michael's opening.  The Cuno case does not suggest that states can't or shouldn't compete for business.  All it does is to identify a narrow range of circumstances where that competition has gone off the rails.  Nothing about the Commerce Clause or the Cuno decision suggests that states can't compete by changing their rates of tax, by changing the basic structure of what they tax, in ways that may make them more hospitable to business.  Certainly, nothing affects their ability to provide improved infrastructure,  improved education, improved services of the kinds that make the most difference to businesses.

What they cannot do it tailor their tax systems in ways that try and target benefits narrowly on those businesses that target their state for economic activity.  That's the kind of measure that raises problems of discrimination, problems of distortion and to which the Commerce Clause does and should set limits.

MR. GREVE:  Thank you very much, Peter.  We'll go directly to Brannon.

MR. DENNING:  Good morning.  My name is Brannon Denning.  I'm an Associate Professor at the Cumberland School of Law at Samford University, in Birmingham, Alabama.  I'd like to thank Michael for inviting me back to AEI, and I enjoy speaking with you and it's a pleasure to be on a panel with Peter Enrich who's really living the law professor's dream.  He writes an article that gets published in The Harvard Law Review and then actually finds a court willing to implement his ideas in litigation.  That's really something unusual that happens in terms of a law review article having a real impact on the way courts do things.

So it's a pleasure to be here and a pleasure to talk about a subject that is near and dear to my heart, the Dormant Commerce Clause doctrine, and I'll try not to induce dormancy in anybody as often happens with my students when we cover the topic.

Michael had asked the question when he contacted me about doing this, and it's presented in the program, the question is, Was Cuno right?  To me, there are two questions that need to be separated out because I think answering that question, you could answer it in a couple different ways.

First, you could ask the question whether Cuno was a defensible application of existing case law.  Then you could ask the question whether the underlying principles that the court applied to the tax incentives and that plaintiffs are asking other courts to apply ought to be revised, narrowed, reexamined, overruled, perhaps.  So I just want to briefly touch on two of these because there is a much larger issue I think lurking in the background that's bigger than this one case, it's bigger than all these individual cases, but it goes really to the heart of the Dormant Commerce Clause doctrine and its future as a judicially enforceable way to ensure competition among the states.

First, was Cuno defensible?  Was it a faithful application of existing case law?  I think the answer here clearly is yes.  As Peter has demonstrated in his article, as two other law professors have demonstrated, Dan Kunin and Walter Hellerstein have demonstrated in another article, there are a line of cases that were all decided fairly close to one another which furnished ample authority for the conclusion of the court which was that tax laws that coerce taxpayers into committing to economic activity are discriminatory in a constitutionally impermissible sense and they violate the Dormant Commerce Clause doctrine.  As the Cuno court belatedly acknowledged, Hellerstein, Kunin and Professor Enrich all had made this case before.

I think people's initial reaction, and I know that particularly people in the State of Alabama, the economic-development people, were hoping that this was an example of a court that had just gone off the rails, that it had just applied precedent, had misread it, et cetera, and that's simply not the case.

That brings me to my second question:  Should the principles that were applied, should the cases that the Cuno case applied be reexamined or narrowed in some way?  Here I think that the answer is also yes for reasons that I'll explain in just a second.

As Hellerstein and Kunin made clear in their article, they reached their conclusion about the impermissibility of these "coercive" state tax incentives.  They acknowledged that adopting their positions would require reading all of those cases that I just mentioned from the Supreme Court for all that they were worth.  I think that this is something that is important to keep in mind.  The court if it grants cert., if it takes up this issue, may not read the cases as broadly as academic commentators and now the Sixth Circuit have read them.

The problem in reading these cases for all that they're worth is, I think, that you end up with a notion of what it means to be discriminatory or what discriminatory state laws entail, that it's so broad that the concept begins to lose meaning as a tool for courts.

There is another law professor, Edward Zelinsky, who teaches tax at the Cardozo Law School in New York who has argued in light of Cuno that and has made the argument elsewhere that Cuno expands the notion of discrimination to the point that it's just useless.  He advocates at loused for tax cases just getting rid of the antidiscrimination principle altogether.  That is radical surgery indeed, but he does have some interesting points that makes in critiquing Cuno and critiquing Cuno's application of the concept of discrimination.

Zelinsky's point, briefly, is that after Cuno, if this coercion as discrimination principle goes forward, the logic of it means that there is no state tax law that is not vulnerable to a Dormant Commerce Clause challenge and that the danger that we run is putting federal courts in charge of tax policy for the states beyond the point that they're already at.

Another point is that Zelinsky points out that the court in Cuno has said that direct subsidies of this same kind of activity are okay or could be okay because the Supreme Court has always drawn a distinction between the taxing policies of states and states providing direct subsidies.  Zelinsky says as an economic matter that doesn't make any sense.  So since it doesn't make economic sense, there's an argument that subsidies now are open to challenge under the Cuno position.

To me at the very least, Zelinsky's critique of the Cuno suggests to me that the court needs to revisit the whole concept of discrimination and provide something of a better definition, one that's not so susceptible I think to relentless expansion and one that would be a little more helpful for lower courts.

Let me parenthetically say that I do think that they have to find a definition because I think that this antidiscrimination principle is at the core of the doctrine's legitimacy, its historical origins and its utility, and if you got rid of that, I think that arguments for sustaining the Dormant Commerce Clause doctrine as a legal doctrine as a check on state action, I think would start to fall away.  So I think that it has to be preserved.

I couldn't possibly suggest to you what the definition ought to be, but let me sketch what I think are two competing visions of discrimination that were argued by both sides.

The Cuno defendants argued vigorously that only those taxes that somehow penalize taxpayers for out-of-state activity or economic action should be unconstitutional.  When I say penalize, it's important to remember that nothing would have happened to DaimlerChrysler's taxes if they had located that plant across lines in Michigan.  Their taxes would not have gone up.  They would have stayed the same as they were before they located the plant.

Moreover, it's important to remember that this tax incentive was available both to domestic and foreign corporations on an equal basis.  This was not an instance in which Ohio was trying to only provide a tax benefit to in-state corporations, much as my home state of Alabama did when it tried to tax the domestic corporations at the par value of their stock and tax foreign corporations at the real value of their stock, and they didn't get away with that.  It's amazing that they tried, but they ruined the state budget.  But those are the kinds of penalties that the Framers, to drag them into all of this, would have recognized as something that ought to be stopped.

On the other hand, this notion of discrimination as coercion I find to be a little troubling.  Under the argument in Cuno, had DaimlerChrysler not had an existing plant in the state and had been lured into the state by the exact same set of incentives, there would be no constitutional problem because under the coercion principle, the coercion operates only on existing taxpayers, that this is the Sword of Damocles hanging over the head of the taxpayer.  That's a little troubling that you could have two exactly similarly situated corporations, both offered the same set of incentives, since one was already existing in the state and the other wasn't, one would be constitutional and the other wouldn't.

The other thing is that I think that despite Peter's statement that he made of course lowering the tax rate for everybody, lowering the corporate tax rate, wouldn't violate the Dormant Commerce Clause because it's nondiscriminatory, if you read the language of the Cuno case and you read the language that they quote from the other Supreme Court cases, I'm not sure that that's all that clear.  You could expand the notion to the point where the argument would be you're lowering the rate of all existing taxpayers in an effort to coercion them to stay as opposed to moving somewhere else.  Again, the language of the Cuno court is very expansive and it doesn't readily suggest stopping points.

There are all sorts of things, moreover, that states do to help business build roads, fund schools, et cetera.  If those kinds of improvements make a business unwilling to locate somewhere else, what's to prevent some other set of plaintiffs coming in and saying, no, what you're doing is you're trying to artificially keep business in your state by improving your schools or roads or whatever, that, too, is coercion, that's discriminatory.

These sound a little far-fetched, but, again, I think that the larger problem is that this notion of discrimination has become very slipper and very hard to get ahold of, and I think that if the court goes whole hog for this discrimination as coercion, Peter will be very busy indeed bringing lots of different cases against lots of activity that heretofore nobody had questioned.

I think I'll stop there and then we can talk about it.  Thank you.

MR. GREVE:  Peter, you may want to respond.

MR. ENRICH:  Let me say a couple of things.  There is a great deal to respond to, obviously.  I think I should start by noting that there is a lot about which we agree, that the decision was an appropriate application of existing doctrine, that the antidiscrimination principle is a core piece of, I think you're saying fundamental constitutional doctrine that should be honored and developed appropriately.

MR. DENNING:  Yes.

MR. ENRICH:  Let me focus on the point of disagreement, and the primary thing that I want to say is if there's one thing that courts are good at, it's drawing distinctions.  It's their meat and potatoes of their whole business.  To worry that the court somehow is going to lose its ability to draw distinctions and throw out all of state tax policy as potentially raising some kind of discrimination strikes me as fantastic.  It's not the way courts act, and I don't mean fantastic as in, wow, good, I mean fantastic as in it's just not what's going to happen.

It's truly ironic that Professor Zelinsky and Brannon are arguing that the Cuno court has opened the door to find everything to be unconstitutional when in fact they were presented with these two very similar provisions, an investment tax credit and a conditional property tax exemption that functioned very similarly.  What did they do?  They said one is unconstitutional, the other isn't.  What did they do?  They drew a line.  I think they actually drew the line a little bit in the wrong place, but only slightly, and if the Supreme Court takes the case, maybe they'll straighten that out.

I can assure you that whether the Supreme Court takes the case or not, what the courts are going to do is they're going to struggle over exactly where to draw those lines.  I certainly don't understand the argument and I certainly would never make the argument that what tax rates of state applies uniformly to all businesses that have a presence in the state, I don't see where you'd even get an argument started that something is discriminatory.

The Supreme Court and the Sixth Circuit talk quite a bit about the impermissible effect of distorting business decision making.  If you took that language completely out of context and said anything that distorts business decision making is unconstitutional, then you'd have a problem, but that's not what the courts have ever said.  In fact, what they've said repeatedly is it's appropriate, it's proper, for states to try to influence business decision making by providing an hospitable environment.  What they can't do, they can't do it in a way which discriminates based on location of economic activity.

Again, exactly how you spell that out is a complex and tricky business, but it doesn't threaten anything like the parade of horribles that Brannon would present us.

Let me say one last thing about direct subsidies and then see where people want to take the conversation.  The court has been very clear that the rules that we've been talking about so far apply to the state when it acts in its sovereign capacity, when it acts as a regulator, when it acts as a taxer.  They don't apply when it is acting as a provider of services, as someone that is operating economic activity that's employing people, that's selling goods.

Exactly how that applies to direct cash subsidies I think is an open question.  How it applies to providing education, training, site assembly, anything like that, no question that those are simply not subject to Commerce Clause scrutiny at all, period.  The Supreme Court has been crystal clear on that.

Professor Zelinsky and Brannon both argue that but economically these are distinguishable.  That may be true.  Politically we all know that they are radically distinguishable.

Why is it that we don't see states handing out wheelbarrows full of cash to businesses to get them to locate in the state?  It requires an appropriation, it requires a tremendous level of political exposure, and it's kind of ugly.  What do they do instead?  They give them tax breaks.  That is attractive, it's relatively politically discrete, no one feels particularly gored by it.  Anyone who's ever dealt with the actual politics of economic development understands that this is a radical difference.

I don't think we need to worry too much about there being a constitutional distinction between the two.  That distinction actually mirrors some important political realities.  Why don't I stop there?

MR. DENNING:  I want to make clear I agree with you on the subsidy point.  I think that not only in how it operates in actual reality but also, again, to drag the Framers back in, I think there are powerful historical arguments for distinguishing subsidies from taxes, so we can put that on the list of other things that we agree about.

MR. GREVE:  Why don't I pursue this and maybe raise the opposite specter?  Peter, you say that courts draw distinctions all the time, that that's what they're in business for and the Sixth Circuit did this.  It's strikes me.  These tax incentives, abatements, shading into subsidies, they come into all forms, shapes and varieties, and I wonder about the prospect of pushing a doctrine and very nice distinctions very, very hard in a myriad of contexts where the distinctions aren't all that clear and we life becomes very, very messy very quickly.  I'll give you one comparison of this.

Once upon a time the Supreme Court held that there's nothing under the Dormant Commerce Clause that requires any particular allocation of business taxation, or apportion I should say, not allocation.  Sorry, apportionment is what I meant.  Then in the early 1980s the Supreme Court waltzed into a series of cases where they decided is there something in the Due Process Clause that requires apportionment formulas or at least put some apportionment formulas over the limit?  What happened was they tried and tried and tried, and at the end of the day they threw up their hands and said we can't make any sense of this because we're not experts at corporate bookkeeping and the Due Process Clause is too blunt an instrument to do anything like that.

The Dormant Commerce Clause now is already very, very, very beleaguered in this Supreme Court and my worry is, and maybe both of you can say something about this, you push it hard in a context like this, whether there isn't the likelihood or at least chance that the Supreme Court might do what it did once before in this context of interstate--

[End of tape 1A, begin tape 1B.]

MR. GREVE:  [In progress] --just throw up its hands and say we can't make sense of it?

MR. ENRICH:  Let me respond just very briefly, and I'd like to hear Brannon's view on this as well.

My read of the court, it certainly is a court that has several member who have some concerns about the Dormant Commerce Clause.  People who want to read the Constitution fairly close to its text naturally are going to say I don't see anything about a prohibition in this text and so I'm not quite sure what to do with that, and both Justice Thomas and Justice Scalia have clearly gone a ways down that path.

As I read them, the point at which at least Justice Scalia quite explicitly stops, as he says, but the antidiscrimination principle is something that we need to preserve and that part he has never suggested any discomfort with.  That doesn't solve the problem of how you draw the boundaries, and it is always going to be a task.  States are endlessly inventive.  There have been literally hundreds of cases before the Supreme Court raising issues about the scope of the antidiscrimination principle,going back to the late 19th century and the court has continually struggled with new and creative state efforts.

Again I think that's probably what the courts are there for.  I don't think the court is about to say we're going to give up this entire game because there's too much that's too fundamental that's at stake.  Will they sometimes get it a little bit wrong?  Sure.  Will they over time get it essentially in ways that serve our national economic interests?  I believe they will.

MR. DENNING:  Michael raises an interesting question.  First of all, Peter is right, there is probably only one member of the court right now, Justice Thomas, who a couple of terms ago said I'm just not enforcing the Dormant Commerce Clause doctrine anymore, I don't believe in it.  I always found it was curious, starre decisis be damned, he just wasn't going to do it.  Scalia has hardened his rhetoric a little bit in recent cases.  In the same term in the same set of cases Scalia said that he would only strike down laws that discriminated, and then he added this curious caveat.  He said, and only in fact circumstances that were precisely like fact situations that had come before the court.  I had never seen that language before and I didn't know if it portended a hardening of his approach or not.

I will note that Ginsburg, Breyer and Souter have all recently dissented in Dormant Commerce Clause cases, some involving state taxation, some involving matters of state tax policy, and even on some discrimination cases that under the case law were pretty clear.  The Chief Justice, assuming that he sticks around which may not be a good assumption, but he has always been fairly hostile to the notion.  So there could be this curious sort of cross-cutting alignment, although predicting these things is impossible, it is clear that some of the justices have been questioning or haven't gone whole hog for the Dormant Commerce Clause doctrine in recent cases.

It happens that sometimes when the doctrine gets in fact situations where it's very complex, and I'm thinking here of Maine's Prescription Drug Program which I argued unsuccessfully--looked very much like a combination tax subsidy program that they'd struck down.  It operated exactly the same way.  The court was unanimous in saying that there was no Dormant Commerce Clause issue at all.  I found that a little troubling until my wife mentioned these people are all elderly and they're worried about prescription drugs.  Of course they were going to uphold it.  I preferred not to adopt that cynical view, but I was a little concerned.

I think we'll be able to tell maybe a little bit about what the court's attitude is when the Direct Shipment Wine case which we have all been anxiously awaiting for 3 weeks is handed down.  There there's the question of whether the antidiscrimination principle is going to trump another constitutional amendment, the Twenty-First Amendment which allows states power over alcohol.  I think how the court comes out on that will be a good weather vane to see how it would react to a set of cases like this.

I have to say that the fact that it's taken them so long to hand down the decision is surprising and not a little troubling.  The oral arguments were held in November and we still have no decision.  Maybe this week.

MR. ENRICH:  Just one more note for the Supreme Court junkies among you.  With regard to Justice Scalia, it's mildly ironic that in the case that Brannon referred to after saying, yes, I'll only apply the antidiscrimination principle to facts that don't extend beyond previous case now, he then proceeded to extend it to a case that went beyond and that he acknowledged went beyond the previous case law.  So exactly where we stand is a little less than clear.

MR. GREVE:  We'll move to questions.

MR. MCDONALD:  I'm Rod McDonald with Emerson Electric Company.  I very much appreciated your discussion.

One context that I'm not sure really came up was the notion of the global context that really these decisions are now made in because typically companies aren't just bidding states off against each other, but states off against countries.  We'll probably talk about this on the next panel more, but from a legal perspective, let's say that the fact pattern were the same but that Chrysler had solicited a bid from Canada with certain tax preferences and maybe a bid from Mexico with free land or various other preferences.  Would this case still have been brought, and what would the court have perhaps done in those circumstances?

MR. ENRICH:  I think there are a bunch of interesting questions that are raised when one brings the international context into play.

One interesting set of questions is to what extent do trade/treaty obligations set limits on what American states or foreign countries can do in this area.  Clearly, both GATT and NAFTA impose some very significant restrictions, restrictions that may well apply to some of the programs that are subject to Commerce Clause challenges.  I don't think that's quite what you were intending to ask.

My sense is that the extent to which state and local incentives are relevant to decisions about international location choices is very, very slim.  The evidence that suggests that they don't even affect most interstate decisions certainly would suggest that they're going to be even less relevant in most international contexts where the factors that are in play in terms of differential labor costs, labor skills, transportation costs, utility costs, regulatory costs, on and on and on, are going to be much larger factors.

Just to come back to something that I said before, even at the federal level there is substantial reason to doubt that tax policy is a major driver of economic location decision making.  Let me just read a very short quote from Paul O'Neill, the former chief executive of Alcoa at his confirmation hearings as Treasury Secretary when he was asked about the relevance of federal tax incentives for business location decisions, and here's what he said, "As a businessman, I never made a investment decision based on the tax code.  If you give money away, I will take it, but good business people don't do things because of inducements."  I think he knew what he was talking about.

MR. DENNING:  One of the interesting things I think that you will see maybe in the call for legislation though, I wonder if despite what Peter says, I think the evidence is pretty interesting that the cites.

I think these state and local governments probably say we need, Congress, for you to pass legislation allowing us to do this because we need to compete internationally and if you don't, they're going to shift jobs out of the country.

MR. ENRICH:  I think that you're absolutely right.

MR. DENNING:  By the way, for some of you who aren't well versed in the nuances of the Dormant Commerce Clause doctrine, it's unique in constitutional doctrines in that the Congress can actually pass laws that reverse decisions, the thought being that Congress gets the power; if Congress is not exercising that power, then these default rules apply that the courts will apply.  But if Congress steps in and acts affirmatively, it can say to the court, no, you got it wrong.  It's a little odd to be talking about Congress overturning Supreme Court decisions, but that's the context.

MR. MURPHY:  My name is Dan Murphy.  I'm with the Corporation for Enterprise Development.  Mr. Enrich, you had said earlier at best that these tax breaks have a marginal effect on business location and you gave three reasons, one of which was that the state and local taxes are too small, but you also said that everybody is playing the game.

I'm wondering if not everyone did play the game if we'd see a different outcome, that in fact, that tax breaks do have a large effect.  Maybe they don't have an effect because everybody is playing it and they're learning they're taxes.

MR. ENRICH:  That's obviously a fair question.  I think that the other two factors that I mentioned are probably the most powerful factors here.  First, that state and local taxes simply are a very small element in a business's cost structure, and that's not just a result of the erosion caused by these tax policy changes, they've never been that large a factor in business's cost structures.  State and local governments aren't that big a piece of the national economy.  It's not ever going to be the fact that they're going to be a major impact on cost structures.

The second is the connection between revenue and services and the relevance of services to business.  Again, I don't think we're going to know the answer because I don't think any state is going to stop unilaterally, and if all states are on a level playing field of being forbidden from using tax incentives, then we don't have a problem where there will be competitive disadvantages.

MR. GREVE:  I'm one of the Supreme Court junkies.  I have a lot of questions about the tax context, but I think that we'll have another panel on that and I'll hold my questions until then.

But I do have one question about this case and other cases like it.  I can maybe see how taxpayers have standing to challenge these property tax exemptions.  I find that hard to believe, quite frankly, about the corporate income tax abatement here.  Has that been a big issue in these kinds of cases, that is to say, that the standing and the identity of the precise parties, and since it could come up at any given moment, is there the odd chance that the Supreme Court might just take off on that question rather than decide the substance?

MR. ENRICH:  One other thing that I'm going to be very interested to see is whether any of the defendants raise that question in their petitions.

In The Harvard Law Review article I have a whole section talking about issues of standing and it's a very complex and very interesting topic.  Since it's one that may continue live in this litigation, I'm not going to say a lot in a public forum about it.

Let me say this much.  We initially brought this case, and I think this is where state tax cases properly belong, in the Ohio state courts.  Rules of standing are rules that vary from jurisdiction to jurisdiction.  Most states, Ohio among them, have much more liberal rules about who has standing to bring challenges to fundamental state/public issues, and I don't think there's any serious question that we had standing in the Ohio courts.

The defendants chose to remove the case to the federal courts where the rules of standing are somewhat stricter.  We had the ironic situation that we the plaintiffs were in the federal court saying there is some question about our standing, you should send this back to state court, because the last thing in the world we wanted was to litigate the thing through the federal courts and then somewhere late in the process have standing emerge and end up being sent back and having to start all over again in the state courts where we clearly do have a right to have our case heard.  So the defendants then were saying we don't think there's a problem about standing.  The judge found that amusing but ultimately decided to hang onto the case, and the issue has not been litigated further.

After the Sixth Circuit decided, then belatedly the State of Ohio said maybe they don't have standing and asked for rehearing on those grounds and the Sixth Circuit chose not to address that.  I think there are some quite strong answers as to why we do have standing even in the federal courts, but you're right that it's a complicated question.

MR. GREVE:  Just to pursue this, you mentioned earlier cases from Minnesota and Nebraska, I believe some place else.  Are those state court cases or federal?

MR. ENRICH:  Again, the only sensible thing to do if you're going to bring a case like this, it's going to always raise a bunch of state bunch law issues.  It's usually going to raise some state constitutional issues.  It's about the interpretation of a complex body of state law.

It would be odd to bring such a case in the federal courts, and none of the cases that I'm aware of have been initiated anywhere other than in the state courts, and I wouldn't anticipate that changing except under quite unusual circumstances.

MR. GREVE:  Are there any other questions?  In that case, we will take a 15-minute break with coffee and chit-chat and we'll reconvene.

[Recess.]

[End tape 1B, begin tape 2A.]

MR. EDWARDS:  Thanks a lot of sticking around for the second panel.  I'm Chris Edwards, and I'm going to be the moderator of this panel which will go through until noon or whenever we wrap up.

The first panel, as we heard, talked about the legal aspects of state tax incentives.  This panel will talk about the economics of state tax incentives.  Before introducing the distinguished panel that Michael put together, let me just run quickly through the four distinct economics views of tax incentives as I see it.

The first view is simply that taxes ought to be neutral with respect to the economy, tax provisoins that drive investment flows over state or international borders are distortionary.

A second is the counteropposite to that.  The second view is that state tax competition is a good thing.  Tax competitoin is a needed restraint on government.  Without competition, governments would have a complete monopoly and with monopoly comes high costs and poor service quality as any economist would tell you.

Of course, we'd prefer tax competitoin in terms of broad tax rate reductions or tax changes rather than narrow tax loopholes or incentives.  One problem with narrow tax breaks, of course, is that they lead to corruption or they encourage corruption.  If government officials have discretionary power over narrow tax breaks or spending handouts, businesses will try to buy them off and/or to bribe them.

A third view is the Ralph Nader view, that corporations don't pay their fair share and we ought to eliminate all sorts of corporate subsidies.  I'm with Mr. Nader on the spending side of state budgets, but taxes are different.  The burden of corporate taxes ultimately falls on individuals, and tax incentives are ultimately tax cuts for individuals.

Peter Enrich was quoted in Tax Notes a few weeks ago, and he tell me whether I got the quote wrong.  He was quoted in Tax Notes saying that tax incentives are "worse than a zero-sum gain.  States are drastically undoing their ability to tax business.  We are seeing a drastic shift in who pays for state government."

With all due respect to Peter, it seems to me that individuals always pay all state taxes in their role as consumers, workers or investors.  And because state income taxes are ultimately hidden taxes on individuals, they've got very high compliance costs, I would argue that state corporate income taxes ought to be repealed completely.

The fourth and final view on state incentives is the starve the beast view.  State governments do not need any more money.  Even if tax incentives don't create the sort of incentive or stimulus that is claimed for them, it's still money that stays in the private sector.  And I would argue at the margin that money in the private sector is more productively utilized than additional money in the public sector.

A final point on that is that if state taxe incentives were banned completely, it seems to me that states would simply compete with handing out more spending-side subsidies which in my view would probably be much worse.

So that's my spin on it, and our panelists will no doubt have different views on it, so let me introduce them now.  They'll each talk for about 12 minutes and then we'll go to some Q and A.

Our first panelist will be Loren Chumley who is the Commissioner of the Tennessee Department of Revenue.  She joined the department's legal staff in 1994 and has served in various positions.  She was the Audit Director from 1999 to 2002.  She's a member of the Board of Trustees for the Federation of Tax Administrators, and she's on the CCH State Tax Advisory Board.

She has practiced law in Washington and in Nashville.  She has focused on bankruptcy reorganization, creditors' rights and commercial litigation.

Our second speaker will be John James.  He chairs the tax practice at Lommen, Nelson, Coles & Stageberg.  His tax law experience includes 4 years as the Minnesota Commissioner of Revenue, and he was for 2 years the chair of the Multistate Tax Commission.

He is a member of several tax advisory groups and he has authored state and local fiscal reform plans.  He writes op-eds on tax issues and he's co-authored Limited Liability Companies which is published by RIA.

Kevin Thompson will be our wrap-up speaker.  He is legislative counsel for the Council on State Taxation where he analyzes state and federal legislation, and he organized COST's advocacy efforts with State Chambers of Commerce.

He has testified before Congress, before state legislatures, and before the NCSL.  Prior to joining COST he worked for a state government relations firm, a political consulting firm, and he has worked for the Democratic National Committee.

With that, we'll kick it off with Loren.

MS. CHUMLEY:  Thank you.  Being from the State of Tennessee, I'm one of those states that has the dubious distinction of finding itself within the Sixth Circuit at this point in time, and I suppose based on the fourth point of your analysis earlier than you presented, Mr. Edwards, I would be the person up here who is the heart of the beast being from state government.  I'm not sure how to take that.

I was listening to the earlier panel and I'm very glad that I got here this morning to hear that.  As I listened to presentations from a macro view about the way that state tax incentives as a whole really don't have that much effect on business decisions, I kind of take that down a notch to what I would call the practical view of every day dealing with phone calls from my Commissioner of Economic and Community Development telling me about the latest prospect, maybe thinking about doing an investment in my state and what is it that we can work out, how can we present what this person's tax consequences are going to be.

At the end of the day what I have found with regard to taxpayers is they want certainty.  They want to know what their liability is going to be, what things that they qualify for, and they want to be able to factor that into a decision.  While it may not be the be-all, end-all for their reason to decide to locate, they certainly want to know what bottom line is going to have on their balance sheet.

We take these phone calls every day and we're dealing in a market--there was a question that was presented earlier about the global marketplace and how that affects state location decisions.  What I would say to you is probably the biggest challenge that we are facing right now is the tremendous loss of manufacturing jobs overseas.  You can open up the newspaper in any given week and see another plant that is announcing it is going to pick up and move.  Being a state employee and going around with my governor on the Jobs Cabinet that he put together when he was first elected and going across the state and listening to the things that the citizens were concerned about, it was, Where am I going to get my paycheck?

So you've got that migration of these types of jobs that are certainly high-wage jobs in rural areas of the state, and some of them even in more urban areas of those states.  And the citizens say to the governor, What are you going to do to make business decide to some here and announce its expansion?

What I would say to that is while it may not be the be-all, end-all, it is a tool in the arsenal that states have with which to put together a package that is going to make the state look as though it is an attractive place to place its business.

In our state, we pretty much have what I would call pretty run-of-the-mill tax incentive programs.  We do a jobs tax credit program that is available based on a certain amount of capital investment and the creation of 25 jobs.  We expanded that program last year to allow a business to qualify if it created fewer than 25 jobs, if it had the appropriate capital investment, and those jobs were created were at a higher-than-average wage in that particular state.

We also have a qualified headquarters facility.  Our governor is very concerned about what I would call almost the two tiers of the work force right now.  You have those people who have typically had the manufacturing type jobs where they have been on the line every day, and yet that's not the market that we're not dealing in today.  So how do you transition these employees into the technology type jobs that are more prevalent in our society today and more higher paying?

When you're sitting there and trying to put together this package, trying to get the headquarters type facilities in your state, those are good high-paying jobs, and at the end of the day I think from our perspective it is the ability to put all of these on paper and to present these to the company and allow them to make decisions taking into account all of these things, again, including what the bottom line on their balance sheet is going to be.

In our state, and again looking at a macro view of what is generally--states collectively as a whole, how much of an impact does this play, I would say we're each different.  Each one of the states is different.  My state made a choice that it was not going to have a personal income tax after--years of battles including rock throwers at the Capitol and horn honkers and so forth, we don't have a personal income tax in my state.  But we have a franchise and excise tax that's placed on businesses that comprises about 12 percent of our tax base, and that's a pretty decent chunk.

We're also a very heavy sales tax state.  Roughly 61 percent of our tax comes from the sales tax, and it's a high rate, anywhere between 9-1/4 and 9-3/4 percent, and business does pay quite a chunk of that.

So I would say when the state has made a choice as to the type of tax structure that it has in place and you have a court decision where we use tax incentives to perhaps try to equalize our competitiveness with the tax base that we have, and you have a court decision that has thrown that perhaps equalizing factor in question, it puts us into a somewhat curious position.

I did get a call from my Commissioner of Economic Community Development a couple of months ago saying he'd just gotten off the phone with his compatriot in Georgia who was just completely thrilled that Tennessee found itself in this position right now in the Sixth Circuit because Georgia didn't feel like it was in the same boat.

So again when I talked about the fact that businesses are looking for certainty, not only do we have the question about whether our tax incentives are in question as a result of the Cuno decision, but we also have questions about what the remedy for that is going to be for those companies who have already come based on a pledge from the state that they would qualify for these incentives.  So I will hush up and turn it over.

MR. JAMES:  I'd like to say first, thanks very much for the invitation.  This is an interesting set of issues and I'm interested to be involved in them by representing the plaintiffs in the Minnesota case challenging the constitutionality of two economic development programs that were adopted by the Minnesota legislature in 2003, one called the JOBZ Program that applies in what we call Greater Minnesota, and then the Bioscience Zone Program which applies to some land in Minneapolis-St. Paul and Rochester.

There are a lot of interesting structural twists on this that make our situation quite different than the Cuno type situation where you basically have a one shot multihundred-million giveaway.  What we've done is retail it.  We have 900 and some odd tax-free zones in Minnesota and there could be more, and the whole thing has been delegated down to the Department of Economic Development level and below.  They're signing contracts to exempt folks from state taxes for 12 years.

So if you're running a business and you have to pay tax and you're running one and you don't, that's the kind of thing we're now getting into in Minnesota.

As I have thought about this, my thinking on it has been heavily colored by the intricacies of Minnesota's particular law, and I wish I could say I was up to speed on the Supreme Court jurisprudence and that sort of thing, but I frankly can't.  There was a day when I was.

I'd start from a conceptual framework where the American Enterprise Institute according to their website is dedicated to preserving and strengthening the foundations of freedom which you describe as limited government, private enterprise and then some other things that aren't relevant here, but those two are.

Then there's the old saying that power corrupts, and absolute power corrupts absolutely.  Because of that, in the United States, and I'm informed, I'm in the midst of reading the biography of John Adams which is just a fascinating book going back to when we were formed, we've emphasized the separation of powers because of the human condition, frankly.  We've had separation of church and state, we've had separation of business and state, we've had separation of powers within the government, executive, legislative, judicial.

We have taxation obviously as a fundamental feature of our government inherent in the concept of governmental sovereignty which is going to be relevant in Minnesota because we have a case that upheld our income tax 65 years ago or whenever, and they talk about that.  We're going to talk about that taxation is an inherent part of governmental sovereignty, it's pretty serious stuff.  I think Learned Hand said the power to tax is the power to destroy.  Oliver Wendell Holmes, Junior, coming out for the other side in a case I think said taxation is the price we pay for civilization.  So it's not just Let's Make a Deal.  There's something special about taxation about the relationship between the citizens and the state, whether you're talking state or federal, obviously.

What taxes we're going to have and what characteristics determine how much each business and individual must pay is generally a legislative function.  The executive administers the tax function, the judiciary decides the disputes.

I think at least as exemplified in the Minnesota legislation that the problems with long-term tax giveaways and business beauty contests go to the very core of the conceptual framework of American society of an American Enterprise Institute's mission, which is I'm just fascinated to be part of a discussion here because I think this is one area in which conservatives and progressives or liberals might come together and agree on something.

Giveaways undermine the integrity of the tax system, starting with the revenue raising capacity.  We don't know how much money we're going to give away in Minnesota.  We've licensed our Economic Development Directors to go to town on it.  As I said, right now there are 900 and some tax-free zones, but the Department of Economic Development as published guidelines and little ads and that sort of thing, illustrations, examples, to use for businesses and they all involve more than a million dollars of savings for business in terms discount at the present value.

Are we looking at $900 million?  Of course, there could be more than one business on some of those sites, which are pretty big.  I don't know, and neither do they.  So it's pretty obvious that if they're going to succeed, they're going to give away a whale of a lot of money and the rest of us are going to be kind of left holding the bag.

A second aspect of this, frankly, is the moral authority of the tax system which I think is in no small amount of trouble in the United States today.  We're in a highly antitax kind of environment and the credibility of government is not very high.  When you have a situation when you guys are in the same business and you're paying tax and you're not, that doesn't do much for the moral authority of the tax system.  We depend upon voluntary compliance and I think we run a risk of undermining it.

Then the last way that this undermines the integrity of the tax system is it takes away, and this goes to your point, Chris, I think to some extent the pressure to have a better tax system for all business.  In Minnesota right now I happen to believe that we tax production in Minnesota too heavily.  I don't buy the theory that General Motors doesn't exist.  You can say that all state taxes are paid by individuals, and at some level that's true.  Since nobody knows exactly how they all play out and to what extent they go on labor and to what extent they go on capital, et cetera, the business firm is kind of a handy place to collect some taxes.

But having said that, it's not so smart to clobber production in your state.  There was a day when we could get away with that, and believe me, we did.  Now in a global economy with mobile capital and all that sort of thing, it's harder, and I don't frankly think we can to the same extent.  I cook up tax reform schemes and they would now emphasize pushing more onto individuals, frankly, unless on production in Minnesota.

If you're spending your time, energy and your political capital doing giveaways one at a time to a few firms, then you're going to have less ability and pressure as a practical matter to fix the system which I would argue badly needs to be fixed.

In Minnesota, the giveaways are done by contract in which the details of who benefits are determined by the Executive Branch which I think grossly violates the separation of powers among the branches of government.  I don't think we want governors or lesser officials out there making multimillion-dollar deals.  That's what we are trying to do now in Minnesota.

Minnesota and Tennessee, it's interesting, when I was commissioner, the Saturn plant was in play and we made a bid.  It wasn't with my help, I might add.  It was the Department of Economic Development.  We lost, you guys won, and I hope it's been good for you and I hope you didn't give away more taxes so that you've ended up netting out to less than zero.

MS. CHUMLEY:  Good.  Very good.

MR. JAMES:  But that was in the early days of this sort of thing, and it's just gone on from there.  The Department of Economic Development is bragging about it in their literature how this a local option kind of thing, so you local yokels can give away 12 years' worth of state taxes.

I think the giveaways kind of blur the distinction or the separation between government and the private sector.  I'm not saying that there is never any interplay.  Of course there is.  But we're talking taxation here which I think is a special aspect of our civil society and I don't think it's a good idea to be doing these deals where you get special treatment.

So this critique amounts to a due process of law critique except it's not typical due process where the state is crushing the individual in one way or another, it's the other side of the coin where the state doing giveaways to individual businesses undermines the constitutional fabric of our civil society.  I don't want to claim the sky is falling here, but I think this pushes in the wrong direction and that it is serious.

I also think that people who consider themselves pro-business might miss this critique because there is a desire for limited government and the critique I have is consistent with that desire I would say.  There is also the view of the federal system as encouraging competition in the laboratory of the 50 states.  I would agree with that and I'd say we ought to push that towards let's have the playing field fair and compete for all businesses, not multibazillion-dollar giveaways for a favored few.

Then, of course, there's the obvious short-term benefit to the affected business.  It's pretty hard to argue that you're not better off if you get a $250 million tax reduction.  As somebody said, it's probably irresponsible for a business not to try for this.

I would argue that the evidence for the existence of a serious problem are these factors.  First of all, we've sent the foxes to guard the henhouse.  You have economic development directors and businesses who each have an interest, frankly, in giving away future state tax dollars.  This is nonsense.  Secondly, it's easy because it's off budget.  We are in perpetual budget crisis in Minnesota.  That has not stopped our governor from wanting to do these giveaways.  It's unaccountable.  There is no pain.

Third, all businesses provide jobs.  Therefore, rewarding some businesses for providing jobs seems a little on the--side.  Fourth, you have the unfair competition and subsidy, and I would think this would be where conservatives would get their antenna up.  It ain't right to tell one business you don't have to pay tax and its competitor that you do.  In Minnesota, in our program it gets to such hilarity that let's say you're in the ready mix business.  I don't think there's probably any place where there's only one ready mix company, but we do have a place where one of them is in a zone and the other guys aren't.  So the guys that aren't in the zone have to pay their taxes to actually fund the government that's going to pay for the projects that the other guy is going to do because he'll underbid him and not have to pay taxes.  Is this nuts?

Then it's human nature to want to succeed and want to look good, and Loren spoke I thought eloquently to that.  Governors, I don't care who, legislators, economic development directors even more so because they are just focused on this, they want to do deals and they want to look good and they want to be a success.  Any business owner would be a complete idiot if he wasn't willing to shake the hand of the economic development director who just gave him millions of dollars and say thank you very much, and by the way, this was necessary.  So it's kind of a partnership there and it kind of circles back to the foxes guarding the henhouse.

It isn't supposed to be a partnership.  There is supposed to be a distinction between government and business especially, I would argue, when it comes to taxation.

Government is widely thought not to be very good, frankly, at picking economic winners and losers, and it's widely thought that government should not try to do so, but that's exactly what they're doing here.

I think it's human nature to seek power and to kiss up to power, for lack of a better way to phrase it.  In government, power tends to be in the executive.  Business has a lot of power today.  The unions have fallen off the charts in terms of countervailing forces we're seeing in our politics.  So here we have the powerful in government and the powerful in business coming together for their mutual benefit.

I think there's huge potential for corruption here.  We're talking about handing out millions of dollars of benefits completely off budget with, frankly, very little accountability.  I don't want to say they don't have reports that have to make and all that kind of stuff, but if you read the list, the list of criteria is as long as my arm to qualify for one of these suckers.  It means that if the local economic development director says you qualify, you qualify.  By the way, they'll bring the zones to you.  So if you're operating a business and you want to expand on the same site, they'll bring the zone right over to you if you've got the right relationship.

This gives the governor, and I'm not taking a shot at our governor, I don't think he had this in mind when he did this.  He was copying a couple of other states thinking we need this.  It gives him the power to try to do things without legislative involvement to favor his friends, and that's not good.  As I said, it reduces the pressure to have a better tax system for everybody, it reduces the revenue raising capacity, and it reduces the moral authority of the tax system as part of our society.

That's a different set of complaints--right into the Commerce Clause, economic discrimination, or the other policy argument which is the alleged stupidity of this from an economic standpoint on which there are lots of studies and I guess some of them go each way, though I do understand that the weight of them tends to be that this is a bad idea.  I would say that the main problem is actually about the structure of our government and the state and local officials, frankly, can't help themselves here.  I'm not sure what we do to help them, but I think they need some help.

MR. THOMPSON:  Thank you, Chris.  Thank you, Michael, and to everyone here at AEI for having this event.

I'm Kevin Thompson with the Council on State Taxation.  COST is a trade association here in Washington, D.C.  We represent about 600 companies, large multistate companies.  Traditionally I work on state tax issues, so I'm a bit of a state tax policy geek.  Every now and then an issue comes up where they let me play up in Congress and work on some other issues in the major leagues and that's what the Cuno has done.

Before I begin, I'm going to talk a little bit about Congress's role in this and what the business community is looking for up on the Hill.  A lot of the characterizations made have been about special tax incentive packages, and clearly those happen.  They make the news whether it's airline companies or computer companies.

The irony though is that what the court struck down in the Cuno is Ohio's investment tax credit which was an investment tax credit was, first, similar to what numerous other states have.  Second, eligible to any taxpayer that meets the criteria.  So while the property tax abatement was clearly a special package for the DaimlerChrysler plant, what the court struck down was a basic investment tax credit that numerous taxpayers have taken advantage of.

Getting back to Congress's role in this, Peter and Brannon laid a good framework constitutionally why the Congress should be involved in this debate.  The court used the Dormant Commerce Clause to strike down Ohio's investment tax credit and what that says, it's a power the court has reserved for itself and it says if Congress has been silent or hasn't spoken on an  issue involving interstate commerce, then we're allowed to interpret that congressional silence.  Then under the Commerce Clause which is an affirmative branch of authority to the U.S. Congress, that says but if Congress wants to come back and trump the court's decision, they have the power to do that.

Late last session when Senators Voinovich and DeWine introduced legislation which would in application overturn the Ohio investment tax credit but was actually a grant of authority to the states saying that that type of incentive at issue, the manufacturing and equipment incentive, was permissible under Congress's Commerce Clause power.

COST is working with about 30 companies, and then another 30 or so state chambers of commerce and other interested parties.  Ernst & Young is also working on this issue.  We saw that there were other cases in other states using similar challenges and Peter alluded to those.

The legal theory that was used here in the Cuno decision isn't specific to the Ohio case.  You could make the same argument to numerous other types of tax incentives that are out there, R&D credits, job training, really any type of incentive that goes against a state's corporate income tax or franchise tax, call it what you may.

What we were looking for was a broader solution, we being the business community, from Congress that would restore the debate to the state capitols and remove it from the federal government, in this case the federal judiciary system.

Obviously, this is a tricky balance to strike because under any legislation from Congress that speaks and gives states the authority to do anything, obviously that trumps preexisting judicial jurisprudence in this area against classic discrimination which is certainly a balance that both states and business don't want to upset.

The simple goal of the federal legislation is to affirm the authority of the states to offer tax incentives for economic development purposes if they so choose.  If Congress does pass a bill, states would still be free not to offer incentives and to structure their tax affairs as they would best see fit.  Then also, it wouldn't strike down any tax incentives because Congress would be giving a specific grant of authority to the states and then providing some limitations under that authority based on classic Supreme Court jurisprudence in the discrimination area.

If there were an unconstitutional tax incentive on the book in a state, they would still be challenged under state law or under existing Commerce Clause jurisprudence.

If a bill were to be introduced, the approach of a broad bill would be to give some certainty to companies who have been relying on these credits and allowing the decisions to be made in the states, and that's what we're looking for from Congress and what the businesses and Senator Voinovich and other interested state and local groups have been working on as far as legislation in the past couple of weeks.  To date there has been no bill introduced.  We're still working and hope that there will be some legislation introduced shortly to give some businesses some certainty in this area and states alike.

MR. EDWARDS:  Thanks a lot, Kevin.  Great comments all around.  I think I agree with a lot of what everyone said.

We'll open it up to questions, and I'm just going to fire off the first one to Loren.  John answered this to some extent, but why is it that you think that in your state there isn't more interest in cutting the broad corporate tax rate in general?  You talked the stability issue.  Businesses like stability, and it strikes me that one of the reasons why you know incentives are probably not a particularly powerful stimulus to business compared to broad rate reductions is because there's less certainty.  It strikes me that states would get a lot more bank for their buck by lowering the broad corporate rate.  You're hanging out a neon sign to business that we're a pro-business friendly state and there is I think more of a sense of permanence with broad cuts.

MS. CHUMLEY:  Our state actually went through a fiscal crisis long before other states did.  In the 2001-2002 time frame we had been going at it since about 1998 as a result of our heavy dependence on sales tax and the erosion of some of our sales tax base from a goods to a service sector economy.

There was a lot of movement.  At that point in time, one of the things that our state did was our franchise and excise tax law at that time was levied merely on corporations.  What was happening was a number of our corporations were moving to a limited liability corporation type structure.  So we ended up extending the tax base to cover all entities with limited liability protection.

There has been a great movement from the business community to try to reduce the rate of our franchise tax which is a tax levied on the deployment of property in the State of Tennessee, and yet it won't ever get traction until we probably have a more broadly based tax structure.

The fact that the citizenry spoke very, very loudly about the concept of a personal income tax in our state I think is going to be the--until there is over all tax reform which I do not see anytime in the next decade, quite frankly, I don't see any type of change in the franchise and excise tax structure simply because it's a function of funding the budget.  It just won't happen.

MR. EDWARDS:  We have a microphone if people have questions.

MR. BRANNON:  My name is Ike Brannon (ph).  I'm with the Joint Economic Committee of Congress.

Mr. James was talking about how this is a conservative entity here at the American Enterprise Institute.  It seems to me that there is almost a conflict that conservatives have to deal with when they look at all these sales tax and property tax giveaways.  On the one hand, I think most conservatives don't like these things because they very much end up being the use of taxes for playing favorites.

I worked in the State of Wisconsin and a lot of these things went to organizations that had no real interest in moving their facilities, but they happened to be politically connected.

On the other hand, you have the interest in federalism.  At what point do you say the federal government should merely leave the states alone and let them do what they want to do?  I want to throw that out and see what everyone's opinions are.

MR. JAMES:  I think on this there's the desire that businesses have for certainty and that sort of thing.  I don't think they should have certainty on this.  Where I draw the line on this one is very clearly that Congress should not act to bless this practice for the reasons I expressed and for the reasons that came up in the prior panel.  The states are kind of out there on their own right now and as governed by the Supreme Court jurisprudence and that's not the end of the world.

I tend to think that we'd probably be better off if Congress would act to ban these practices, but that gets you into a whole big sticky area of states' rights, and the states themselves have historically, I remember from my days chairing the Multistate Tax Commission, we couldn't get together on much of anything and this was a bunch of like-minded states.  They had this goal of uniformity, and the notion that the states would invite Congress in to legislate in the state tax arena is, even though it would probably be a good idea in a globalizing economy in which our states are less and less really important and the global economy is the big thing, that's a tall order.

If we were to do that, then I'd have a whole set of ideas about what we might do, but I think that's a much more complex question.  It's easy for me to say, no, don't bless this practice than it is for me to say that you ought to step in and act.

MR. THOMPSON:  I don't think Congress is blessing if they were to act.  I don't view the bill as blessing tax incentives.  I view it merely as Congress affirming the authority of the states to decide their state tax systems.

You raise a great point.  This debate in particular does make perhaps strange bedfellows on both the conservative and liberal side on this area.  I think we are among the groups that find some uniformity or middle ground is the fact that many groups traditionally on the state side have asked for, or one of their core principles is that the federal government should not be involved in their state tax policy system and dictating to them how they should structure their affairs, and that's what this bill would say.  It would say that the federal government is not doing that and it would return the authority back to the states in this area.

I think there is perhaps a potential credibility issue if a lot of these state government groups were to come out and oppose this bill from the perspective of saying normally we're all about federalism and states' power, but in this instance we just can't help ourselves, we can't save ourselves from our ourselves.  I think it certainly runs afoul in some previous statements those groups have made in Congress in supporting other acts such as--project and also the Mobile Telephone Sourcing Act from I believe 2000 where you had states and businesses supporting congressional legislation.

MS. CHUMLEY:  I'm going to go to your comments and something that Mr. James said earlier.

We use taxation to encourage of discourage behavior all of the time whether it's higher tax rates on tobacco products that some state legislators might use in order to perhaps discourage smoking.  I would say to you that most states view tax incentives as trying to incentivize job creation.

One of the concerns that I have on the Cuno decision specifically is if you take this much further, then are you in fact pushing states toward adopting a uniform tax structure across all of the states in this perspective?  What I keep hearing is either saving states from ourselves or helping the states along, bless our poor little hearts as we say in the South, it's almost a wee bit patronizing there.  As a sovereign state I think we should be entitled to make these decisions on our own.  Frankly, they may not be the best decisions in the minds of those who have the time and energy to push this type of litigation, but my state legislation is going to be debating the issue of whether motorcycle riders can ride without a helmet on Wednesday, and guess right, that's their right to do that from a sovereign state standpoint even though the weight of authority would say probably not the best idea.

On the idea of federal legislation, I was pretty involved when Congress was dealing with the Internet Tax Freedom Act.  It seems like it was just yesterday, and it's popped its head back up again.  So I have some reticence whenever Congress gets involved in this area because I'm never sure of the scope that it's going to take.  Yet I would say that the National Governors' Association has expressed support for the concept of this federal legislation, tax administrators will line up behind it, but what I would say as a caution to those drafting the legislation is we need to ensure that the words that Congress passes are the correct words in the bill.

MR. JAMES:  Could I add just a little on the subject of federal legislation?  I could imagine legislation that would just go down the lines of saying you can't do these one-of kinds of things.  Now that gets into the problem that you have in the Internal Revenue Code which is if you born on August 15, 1947 then you qualify for this or that, and maybe you never get away from that entirely, but that surely isn't going to tell what kind of tax structure they ought to have.  It's telling you you can't do this kind of thing because we think this kind of thing gets into serious problems with separation of powers and that sort of thing.

I think it could be done not on interfering with federalism kinds of grounds, although you'd always have that argument, but the contention would be what you're doing is solving a structural problem that we have given human nature and the special role of taxation in our society.

MR. EDWARDS:  John, to go back to the contrasting view that you and Kevin had on incentives.  I agree with you entirely, but the corrupting nature of very narrow incentives, Kevin pointed out that the Cuno decision regarded a broad-based investment tax credit which I think dozens of states have.  What in your mind is the difference between broad-based sort of incentive and narrower incentives?  Do you think that investment tax credits are a reasonable policy?

MR. JAMES:  I would say a broad-based incentive would be a general provision that applies more or less across some board.  You can't say literally across the board.  Whereas the kind of thing that I think is objectionable is where you have something that's just focused on one deal where it's Let's Make a Deal.  I think you should ask Peter on the niceties of the Ohio investment tax credit.  I'm not sure.  I could imagine an investment tax credit passing muster, but when I read the materials on Cuno I definitely was on his camp.  So I guess I'm not prepared to say exactly how you might make that distinction.

But clearly, if there were to be legislation or a judicial decision that was aimed at doing something here, I think it ought to be pretty narrow and it ought to be aimed squarely at the Let's Make a Deal special incentive for one outfit kind of situation.

MR. MCDONALD:  Rod McDonald with Emerson.  Loren, what is the current situation in the State of Tennessee given the Cuno case's decision.  The sort of betting here in Washington, D.C., is this is just one circuit that so far has heard this case, that the Supreme Court, at least the betting is, won't take this case and you will be in this special group for some time.

MS. CHUMLEY:  It's so special.

MR. MCDONALD:  What's the current status?  What has the court told you at your state you have to do, and what are you going to do?

MS. CHUMLEY:  We do not actually have the specific investment tax credit that was at issue in Ohio, so it really comes down to a function of interpretation:  Do we believe that the reasoning of Cuno applies to our jobs tax credit legislation or our other incentive legislation that's out there.  From the state's perspective it's going to require specific litigation on those credits in order to declare them unconstitutional if that's the approach that will happen.  So we are continuing to apply those laws and we'll continue to do so.

We are in the process of determining whether or not we should pass a different type of incentive legislation, but we haven't gotten there yet.  So as far as we're concerned, the Ohio case is distinguishable from the incentives which exist in the State of Tennessee.

MR. JAMES:  May I add a little something in the Minnesota context along those same lines?  In our situation, Cuno was just almost an afterthought, frankly, in our litigation because we've got some state constitutional provisions and it looks like they just ran red lights.  I actually thought that the state might announce that they're suspending the program pending the outcome or something like that.  They have chosen not to do that, but there is definitely a cloud hanging over these economic development programs at this point.

But I think given that these were centerpiece programs for the governor, there's a certain reluctance to admit that there might be any problem unless and until the courts actually tell him so.

MS. CHUMLEY:  And I would agree with that.  We've got a law on the books.  It's our job to administer it.  How can we not?

MS. STARK:  I'm Nancy Stark (ph) with the World Policy Research Institute, WPRI.  It's based at the University of Missouri but it's nationwide.

I wanted to raise a broader issue that grows out of this.  Because state business incentives have been with us for so long, one of the things that's happened going down on the substate level is that it's very difficult to get local elected officials and other civil leaders to see something other than, I'm exaggerating, but tend to focus on business incentives and the waving the money and going back to the governor and asking for business incentives.

It's really hard to get people to focus on the other things which probably will make for better economic development in the long run like educational services, job training and deployment of broadband and all those things that might help rural areas.  I was wondering if you had any comments on that.

MS. CHUMLEY:  In my state, we tend to try to pull together a very broad package.  My perspective is somewhat limited because I am the Revenue Commissioner so I typically come at it from the tax angle, and those are the questions that I get.

I can tell you that one of the jokes in our state is asphalt is king, so we have a very good road system in our state, and that's one of the advantages that we always try to sell is the central location and the fact that you can access to markets within less than a day's drive.

It is about cheaper power that's typically offered through the Tennessee Valley Authority, the road structure, what are going to be the training grants that are out there for the employees.  I would say we go in with a pretty broad-based package in our state, so that has not specifically been my experience.  Others may have had other experiences.

MR. JAMES:  I do think it tends to be a problem.  It expands my comment that this takes the pressure of trying to make the tax system better.  It also takes the pressure off of perhaps doing other things, frankly, a lot of which could be done from the state legislative level.

In Minnesota, one of the stories about how this law came to be enacted is that we've been in this budget crisis as our tax system still assumes that the bubble never burst.  We've had a crisis and so they cut local government aid.  The JOBZ Program, Job Zone Program, was seen as a sop to local governments:  while we can't give you real money, local government aid, but here you can go do this to gin up some jobs.

Then the other aspect that's relevant to your question is not only is it hard for them not t focus on this, but how could they focus on anything else because they're giving away the state's money?

We have tax increment financing which is a religion in Minnesota.  It's very complicated, and I don't purport to understand it, but there there is at least a fig leaf and the companies have to pay taxes.  Way back when I was Revenue Commissioner which is 15 to 18 years ago, I had an assistant commissioner, a very bright guy, former Chair of the House Tax Committee who was just worried sick about TIF and the percentage of the business property tax base that was in TIF districts which was going up then and is higher now.  Without question, that has taken off some of the pressure to make our property tax system more rational where we imported the concept of progressivity into our property tax in totally insane fashion a very long time ago.  There was a time when business property paid 5-1/4 times the amount of tax on a dollar that homes paid.  Now it's down to about 2 or 3 or 1 before you start factoring in other complications which probably make it worse, but the same kind of a problem.  When you have this, it tends to be used and used a lot.  Again, people want to make deals, they want to feel like they're a success and businesses are darn fools if they won't take advantage of it.

MR. EDWARDS:  John, do you think of tax incentives were banned that states would compete more with the spending incentive and so-called training and all that kind of stuff, and would that be just as bad?

MR. JAMES:  No, I don't think it as bad.  I'm a tax freak.  I'll admit it.  I have this sense of what's far and what's in the world of taxation.  I think taxation is a special aspect of our civil society and so I am not as upset about other kinds of giveaways.  They're a heck of a lot harder to do, to start with, because you only have so much money and that's one reason these suckers really appeal is that you're giving away money that's off budget and that you, therefore, never will have.

I think, sure, there would be other kinds of competition.  For the most part, I think I'm with the folks that see federalism as one big experiment with 50 competing jurisdictions and let them go at it, but perhaps because of my feelings about taxation, I draw the line there.

MR. MEZEROFF:  I'm Michael Mezeroff (ph).  I'm with the Center on Budget and Policy Priorities.

This is question for Commissioner Chumley.  You had a caution at the end of your statement about the federal legislation, cautioning Kevin, be sure you get the words right.  My question for you is, given the long history of congressional intervention in state tax policy with things like the 4R Act which your state has litigated, with the Internet Tax Freedom Act where it took 2 years of hard lobbying by the states to turn a piece of legislation that just started out in a way that would have been disastrous for rational tax policy into something that states can barely live with.  Why are you confident that Congress can get a bill right where Congress is being invited to sanction state tax discrimination and define the lines between what is discriminatory state policy and what isn't given the fact that there is a long his