Let States Be Entrepreneurs

Last week the Supreme Court heard arguments for and against the proposition that "entrepreneurial federalism" is unconstitutional. No one used that phrase, but it captures what the court is pondering: When states compete to attract businesses by offering tax and other incentives, are they violating the Constitution's Commerce Clause? It delegates to Congress the power to "regulate commerce... among the several states."

In 1998, Ohio granted DaimlerChrysler substantial tax benefits--all states offer similar incentives--to expand a Jeep assembly plant in Toledo rather than moving operations to Michigan. A federal appeals court disapproved the deal, ruling that it unconstitutionally interfered with interstate commerce by favoring companies expanding in one state. The case was brought to court by some Ohio and Michigan taxpayers who said--correctly, but irrelevantly as regards the Constitution--that such state policies shift tax burdens from businesses to individuals.

The Supreme Court must first decide if these taxpayers even have standing to sue. If it says they do, taxpayers everywhere will flood the court system with litigation to express their political objections to tax policies. If the court improvidently allows the case to proceed to the question of the pertinence of the Commerce Clause to 50 states' policies, the court will find that the plaintiffs' argument assumes something odd. It assumes that Ohio's deal disrupts the "natural" flow of economic forces across the nation in which market forces are not otherwise deflected by states' differences. Actually, the nation is planted thick with the 50 varying systems of laws and regulations that burden or facilitate commerce in different ways.

Does the Supreme Court really want to inundate itself with cases requiring it to make thousands of rulings about which state laws and actions do and do not violate some standard--which the court has yet to devise--for permissible state actions that affect commercial practices? Does Ralph Nader, who favors the taxpayers' suit, really want states' differences in environmental and other policies, with their different impacts on commerce, to become constitutionally problematic?

Well, actually, some liberals do want that: They think it would prevent what they consider a "race to the bottom" and conservatives consider a "race to rationality"--competition between the states to reduce taxes and other costs borne by businesses.

Ohio, like almost all states, is practicing "entrepreneurial federalism." One state--Nevada--is a monument to that. In 1903, with the Comstock Lode's silver exhausted, Nevada, with a dwindling population and desperate for commerce, passed a law exempting corporations from taxes and most supervision of business practices. Other states blunted Nevada's appeal by moving in the same direction, so Nevada found a new niche for uniqueness--divorce law.

Federalism had always encouraged "migratory" divorces as people sought the least demanding jurisdictions. For a while, Indiana and Illinois set the pace, then the Dakotas. But Nevada lawyers advertised in Eastern newspapers that their state had the nation's shortest residency requirement and most numerous and easily proved grounds for divorce--and no impediment to immediate remarriage. In 1931, when there were rumors that Idaho and Arkansas might match Nevada's three-month residency requirement, Nevada reduced it to six weeks. And, spotting another business opportunity in the federal system, Nevada legalized gambling, in part so that the mostly affluent people who traveled to the state for a divorce could entertain themselves while there.

Regarding Ohio's successful courtship of DaimlerChrysler, the grievances of Ohio's and Michigan's taxpayers, valid or not, are political grievances for which there are political remedies--elections, which can change policymakers. The taxpayers have, in the modern manner, cast their complaint as a constitutional controversy. But much of their complaint is that entrepreneurial federalism sometimes does not make economic sense--it costs too much per job created. To which the wise response is: Well, yes, but so what?

If "foolish" or "inefficient" were synonyms for "unconstitutional," the court would strike down much of the government. Of course entrepreneurial federalism sometimes fails to achieve cost-effective results--it is a government program. But entrepreneurial federalism can work very well indeed: Officials in Alabama, which used $253 million in incentives to defeat South Carolina in a competition to win a Mercedes-Benz plant, claim the cost was recovered in five years, and the deal led to landing four other auto plants.

To the extent that constitutional limits are placed on states' abilities to compete to produce business-friendly policies, to that extent state politicians will feel free to impose burdens on businesses that are captives without alternatives. Entrepreneurial federalism puts useful pressure on states and localities to heed this axiom: Capital goes where it is welcome and stays where it is well treated.