EconWar




AMICUS CURIÆ BRIEF

(John Locke Foundation, Inc.)




Index

Question Presented
Interest of the Amicus Curae
Statement of the Case and the Facts
Introduction
Argument -- G.S. 158-7.1 Fails the "Exclusive Emolument or Privilege"and Public Purpose" Tests of the North Carolina Constitution, Article I Section 32 and Article V Section 2

Section I. Overview of North Carolina Economic Development Policy
Section II. Government Incentives Given to Private Firms Do Not Serve a Public Purpose
Section III. Political Favoritism is an Inherent Byproduct of the System of Government Recruitment Incentives


Conclusion


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Question Presented: Did the Trial Court Err in Invalidating G.S. 158-7.1 as Violative of the North Carolina Constitution?


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Interest of the Amicus


The John Locke Foundation, Inc. is a nonprofit, nonpartisan public policy think tank that examines state and local issues in North Carolina. The Foundation conducts research, publishes studies and periodicals, provides testimony and information to governmental bodies, and participates in public discussion about policy issues facing North Carolina.

The Foundation represents no industry, association, or narrow interest group. Instead, it seeks to advance the public good through research, analysis, and commentary. Because of its interest in economic policy in particular, and its belief that the public good is the only just and constitutional goal for governmental policy, the Foundation has asked leave to file as a friend of the court in this important case.

Appreciation is extended to Thomas E. Vass, a student of North Carolina economic history who contributed greatly to this brief. He is a private portfolio manager and is the president of Business and Family Financial Strategies, Inc. located in Raleigh.

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Statement of the Case and the Facts


Amicus Curiae adopts the Statement of the Case and the Statement of the Facts from the Brief of Plaintiff Maready.

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Introduction


North Carolina Constitution Article I Section 32 provides that "no person or set of persons is entitled to exclusive or separate emoluments or privileges from the community but in consideration of public services."

North Carolina Constitution, Article I, Section 35 provides that "a frequent recurrence to fundamental principles is absolutely necessary to preserve the blessings of liberty."
North Carolina Constitution, Article V, Section 2 (1) and (7) provides:

(1) "The power of taxation shall be exercised in a just and equitable manner,
for public purposes only, and shall never be surrendered, suspended or contracted away."
(2) "The General Assembly may enact laws whereby the state, any county, city or town, and any other public corporation may contract with and appropriate money to any person, association, or corporation for the accomplishment of public purposes only."
This brief argues that General Statute 158-7.1 is unconstitutional on its face and as applied in that it is inherently violative of these constitutional provisions.

The briefs of other parties and amici approach the question with traditional legal materials. But constitutional requirements to use public funds only for public purposes have an economic rationale, which this brief presents to the Court. This rationale demonstrates not only that a meaningful definition of "public purpose" would preclude practices such as those contained in G.S. 158-7.l but also that the affirmation of the "public purpose" doctrine will not harm the economy of North Carolina. It will enhance it.

Since some of the sources cited are not available in the Supreme Court Library
the appendix includes copies of relevant portions of some of the materials.

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Argument


G.S. 158-7.1 FAILS THE "EXCLUSIVE EMOLUMENTS OR PRIVILEGE" AND "PUBLIC PURPOSE" TESTS OF THE NORTH CAROLINA CONSTITUTION ARTICLE I SECTION 32 AND ARTICLE V SECTION 2.
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SECTION I. OVERVIEW OF NORTH CAROLINA ECONOMIC DEVELOPMENT POLICY

The issue of how best to expand economic opportunities for North Carolinians is hardly a new one. In every administration and legislative session into the last century the issue has come up in one form or another. Typical of the dialogue is a March 23, 1955 address by Gov. Luther M. Hodges to the North Carolina Citizen's Association of Raleigh. Messages, and Public Papers of Luther Hartwell Hodges, Governor of North Carolina, 1954-1956, Volume I, (North Carolina Council of State, 1960) pp. 105-109.

The governor began his speech with a review of North Carolina's spectacular industrial recruitment successes with firms in the electronic component manufacturing sector. After reviewing these successes Hodges noted, with caution, that North Carolina's citizens had not enjoyed rising per-capita incomes relative to citizens of other states. "Despite [recruitment successes], we find ourselves in no better relative position than we were thirty years ago, ranking 44th out of 48 states in per-capita incomes," he said. Hodges concluded by enunciating a public economic development plan based upon "a determined drive to attract outside capital to North Carolina."

This three-part economic policy statement--touting successes, bemoaning the state's continued relative poverty, and then proposing solutions--has been repeated throughout the century by North Carolina governors. Thirty years prior to the Hodges administration, Gov. Angus Wilton McLean repeated the three-part policy statement in his Biennial Message to the General Assembly. "North Carolina neither baits nor coddles big business," he said. "Every honest enterprise is encouraged and is justly treated by our state government in the enactment and administration of our laws. On account of this fair and just attitude toward outside capital, our state has in the past twenty-five years shown a greater rate of progress in industrial development than any other state in the Union." Still, he concluded, North Carolina remained relatively low in economic measures, and more economic development efforts were needed. "Biennial Message to the North Carolina General Assembly," Public Papers and Letters of Angus Wilton McLean, Governor of North Carolina, 1925-1929 (Edwards & Broughton, 1931) p. 73.

Throughout the years such efforts by state and local governments in North Carolina have been the subject of controversy. Some North Carolinians have advocated a larger governmental role in promoting the state or particular regions of the state to outside industry. Others have proposed a smaller governmental role, or a different one. Furthermore, policymakers and economic developers have disagreed about the importance of various factors in fostering the creation, expansion, and relocation of businesses. These factors might include wage rates, availability of labor and capital, tax rates, skill levels, transportation options, and access to consumer markets.

Similar debates continue today. But the relatively recent government policy ofproviding cash or other direct, targeted incentives to individual companies--incentives not available to all firms, but only to particular ones selected through political rather than market means--represents a distinct break from North Carolina's past economic development debates. The new practice raises the constitutional issue because of its relationship to the exclusive emoluments or privileges' and public purpose' doctrines. Other government policies might prove to be unwise, counterproductive or irrational.
But an economic policy can be irrational and nevertheless be constitutionally permissible.

The use of tax revenues on a selective basis to promote the private purposes of individual firms, however, is directly opposite to the pursuit of the common good. This practice relies upon the unreasonable assumption that governments can best judge which businesses will contribute the most value to an economy, because the government is taking money away from some firms, workers and consumers--through taxation--and giving it to others. This "opportunity cost," is never factored into the equation which government officials use to justify their policy. Their focus is merely on the jobs or economic opportunities that appear to be created, not whether there is a net expansion of jobs or economic opportunities once the opportunity cost of the policy is subtracted.

Empirical research suggests that cash and other targeted state incentives have not provided a net economic gain in any jurisdiction. Instead, academic studies examining the subject have found that such incentives bear no statistically significant relationship to measures of state economic performance or well-being. The most comprehensive of these studies is by Margery Marzahn Ambrosius, "The Effectiveness of State Economic Development Policies: A Time-Series Analysis" 42 Western Political Quarterly 283 (Spring 1989) which is included in the Appendix. Ambrosius concludes, at 294:
"In no case, however, does any one of these economic development policies demonstrate an unequivocally positive, measurable overall impact on either of the indicators of state economic health.

By using methodology which has not previously been used to analyze the effectiveness of state economic development policies, considerable support is thus given to previous findings that these policies have no beneficial effect on state economies. In fifteen of the sixteen analyses, these policies have no demonstrable positive effect on the economic health of the adopting states, as measured by per capita manufacturing value added or by the unemployment rate."

This means that such incentives merely redistribute jobs and growth from one area to another, or one firm to another, or even one individual to another. Targeted incentives are not broadly available and do not promote the public good as a whole. They advance a private, not a public, purpose.

It is not enough for a government to intend for a tax-funded subsidy to benefit the economy as a whole rather than simply the firm to which it is given. If intention alone is allowed to define "public purpose", then it has no meaningful definition. If the constitutional test for "public purpose" is anything more than an inkblot, then it must be based on a reasonable expectation of net social benefit. The next section demonstrates that such an expectation is inherently impossible with regard to the incentive practices at issue.
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SECTION II. GOVERNMENT INCENTIVES GIVEN TO PRIVATE FIRMS DO NOT SERVE A PUBLIC PURPOSE
How profits may be used in society to achieve a public purpose was analyzed by Thomas Aquinas. Aquinas began his analysis by reviewing the philosophical debate over the activity of trading and the behavior of the individual trader. Aquinas was interested in demonstrating that an individual trader could be considered a moral person, even if the activity of trading may be immoral because it may generate profits in excess of the "just" price.

The resolution for Aquinas lay in determining whether the profits were subsequently used to promote the public good. Aquinas developed a three part categorization of the use of profits which would be used to guide judgments about the use of profits. If the trader pursues an "honorable" purpose with the profits, then profits are justified. The three allowable purposes for profits were self-support, charity, or providing the public with goods., and thus serving a "public service." Henry William Spiegel, The Growth of Economic Thought, (Duke University Press 1983) pp. 57-61.

Writing in 1776, Adam Smith, in The Wealth of Nations, made the link between profits and the public good. Smith described how a society that relied upon competitive market transactions between sovereign individuals would achieve greater prosperity for the entire nation than a society that relied upon government-directed economic policy. See especially Chapter II "Of Restraints Upon the Importation from Foreign Countries of Such Goods As can be Produced at Home" in Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (Random House 1937).

The branch of economic theory employed by Smith eventually became known as "general equilibrium welfare economics." It is from this theoretical perspective that the arguments against the "public purpose" of tax revenue-based incentives are made. Smith contended that every individual would endeavor to employ capital in support of domestic industry for practical reasons.
A "stateman who should attempt to direct private people in what manner they ought to employ their capitals, would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it." Id at 423.

One of the leading scholars in welfare economic theory was J. De V. Graaf, who described what transactions occur in the free market to bring all the actors to market welfare maximization:
"The familiar result that perfect competition will, under certain circumstances, lead to an optimal allocation of resources is based on the satisfaction of the above marginal equivalences. Profit maximizing entrepreneurs will attempt to equate their marginal private rates of transformation to given price ratios. Since uniform price ratios will prevail on a competitive market, the marginal private rates will be the same in every firm. If, then, the marginal social rates are everywhere equal to the private ones, or if they are everywhere k times them (where k is any constant), they too will be the same in every firm."

J. De V. Graaf, Theoretical Welfare Economics, p.22.

What Graff was suggesting was that marginal equivalences, achieved through price adjustments in the freely competitive markets, would eventually lead to both maximum efficiency in the use of resources, and maximum welfare of the participants, given an existing distribution of income.

The key economic piece of information that all consumers and firms regard in making their decisions is price. It is the price of goods and services, freely determined in the market exchanges between sovereign consumers and profit maximizing firms that allows the adjustments of marginal rates of transformation of resources into finished products, and then the consumption of products into consumer satisfaction.

In the absence of government intervention in market exchanges, or monopoly power in production, economic welfare theory predicts that participants in the free market price system will seek and find maximum welfare for all. The ultimate outcome of maximum welfare is best viewed with the help of an economic diagram, reproduced on page 28 of the Appendix, that describes how the participants in the free market interact with each other.

The diagram and the accompanying narrative are taken from an introductory economics text by James Quirk and Rubin Saposnik, Introduction To General Equilibrium Theory and Welfare Economics (McGraw Hill 1968) pp 27-36. The diagram is useful for two reasons. First, it shows the general concept of how an expanding production possibilities frontier is related to improved welfare for producers and consumers. Second, it supports the assertion that industrial recruitment incentives create perverse economic welfare outcomes as a result of government intervention in the free market price system.

The provision of industrial recruitment incentives acts as a price subsidy to a specific firm selected by the government over any other firm that may also make an investment under conditions of consumer sovereignty and free market exchanges. When government intervenes in the market, as in the case of industrial recruitment incentives, the ratio of net return to capital is not the same for all savers and investors.

In this less-than-perfectly competitive market, the ideal theoretical benefits of welfare maximization predicted by economic theory fail to occur. Some firms benefit from the government intervention, while other firms do not. Some consumers benefit from the government intervention, while other, morally equivalent, citizens do not benefit. The government, not the autonomous workings of the free market, determines who will win and who will lose as a result of the use of the incentives.

Once the process of government incentive price subsidies begins, a number of perverse market adjustments and consequences result, none of which has a market-based resolution that would restore price as the key information variable. The process of private investment decision-making becomes more and more politicized and arbitrary, and less and less autonomous.

In the first instance, the price subsidy distorts the rate of return throughout the capital markets that all firms use to judge the profitability of investment alternatives. The government incentive acts to drop the real rate of return of the recipient firm, compared to the prevailing market rate of return for non-recipients, thus making socially inefficient investments possible and more likely to recur.

Second, in the absence of a market-derived, commonly observed rate of return, the socially optimal rate of investment does not equal the time preferences of consumers for present versus future rates of consumption. It becomes more rational for nonrecipient firms, who are not initially blessed by government largesse, to begin searching for incentive handouts and focusing their attention on obtaining easy government revenues, not on obtaining the more difficult market derived profits. The rate of investment declines for profitable enterprises that would be undertaken, thus adversely affecting consumption in future periods.

The government handouts serve not only to produce socially inefficient investments that would not otherwise be undertaken in the competitive market, but also serves to distort the rate of investment required to produce optimal levels of welfare in the future. This process eventually leaves the government as the sole arbitrary force in determining both the socially optimal rate of investment for the future and the type and location of investments that will occur.

Third, the government subsidy is designed, according to its proponents to create "more jobs." It is actually the derived stream of income from the "more jobs" that the proponents should be stressing, because it is income that allows consumption in the free market. This act of consumption is linked to welfare maximization of consumers.

The "more jobs" provided by incentives produces a stream of income that may or may not have been present in the economy prior to the incentive. If "more jobs" is created when "more jobs" is not required because of full employment, then the government incentive serves to squeeze other more socially beneficial investments and capital out of the market.

In other words, the government not only determines who wins and loses, but its action with the incentive has a secondary effect of squeezing other investment alternatives out of the market. It is not, then, rational for non-recipient firms to either commit capital to investments that would compete with the government subsidized investments, or to invest for future time periods, given capacity constraints in the labor market.

Fourth, while dropping the real rate of return for the recipient firms, the government lowers the risk of failure for the firm compared to the higher risk levels faced by non-recipient firms. The subsidized firm has a lower level of commitment to the success or failure of the investment because less of the firm's own capital is invested. The incentive acts as an insurance policy for the recipient firm. If and when things go bad, or if and when some other state offers a better incentive deal, the firm has less at risk in abandoning the project.

This type of government intervention becomes self-perpetuating. If it took a government subsidy to recruit the firm to the location, and that subsidy helps promote a lack of commitment to the investment, then it seems likely that it will take more incentives to keep the firm from leaving. Unless the government continually meets the competitive bids of other states, the firm, basing its decisions on the political process, and not the market rate of return or market rate of risk, will continually extract greater incentives from the government agent in order to stay.

There is some evidence that firms are using this ploy to extract higher incentives to remain in North Carolina. In "Goodyear's flip side a downside", Stella Eiselle of the Charlotte Observer reported on August 10, 1995, that Goodyear Tire and Rubber received $180,000 from the Governor's Industrial Recruitment Competitive Fund to locate a plant in Statesville, without informing government agents that the move to Statesville would mean shutting down its plant in Charlotte. When informed of this information oversight, a representative of the state declared, "I do wish that we had known (of the closures). It's just not relevant...We're still thrilled that we provided a $180,000 grant."

Fifth, over a period of time, the price subsidy to the recipient firm distorts the adjustment relationship between returns to capital and returns to labor that are expected to occur in a competitive market. In perfect competitive equilibrium the marginal equivalency of profits to consumer satisfaction is reached after a series of price-based exchanges. By providing the incentive, the government allows higher nominal returns to be achieved by the firm, vis-a-vis non-recipient firms than is consistent with the payment of lower wages that prevail in the labor market, although the return appears lower when the government's subsidy is counted as part of the recipient firm's investment.

Given a highly automated or technologically advanced production process, the subsidized firm can match low-skilled, low-wage labor to the equipment, and take the incentive as unearned profits. The repeated use of the incentives over time by the government serves to erect a permanent barrier to the expected rise in wages that would occur in a competitive market by distorting the equilibrium of the adjustment process in returns to capital and labor.

There is some evidence that this government intervention explains the historical persistence of low wages and low incomes of North Carolina workers. In its October 1977 analysis of jobs recruited to North Carolina, the North Carolina Department of Administration found that since 1970, the mix of new jobs in each class of indices had on average paid less than existing North Carolina jobs but because more jobs overall were in the high wage/fast growth and high wage/low growth categories, the average wages for all manufacturing continues to increase." "A Balanced Growth Policy for North Carolina" (Appalachian Regional Commission Investment Policy for F Y 1978) p. VI-22.

This tends to support the assertion that incentives distort the relationship between returns to labor and returns to capital. The government which provides the incentive is assisting in the process of permanently locking North Carolina's manufacturing workers in the lower wage labor market. The subsidy acts to skew the market's ability to seek maximum welfare outcome between capital and labor that macroeconomic theory predicts will occur at equilibrium.

One of the outcomes of this incentive-driven investment process is that workers in the lower wage firms, in the aggregate, will never achieve the level of discretionary savings that are sufficient to initiate the process of self-renewing capital investments. Not only does government intervention distort the competitive relationship between capital and labor, incentives act to make this discriminatory relationship a permanent feature of North Carolina's economic development process. In the words of Adam Smith, the government agent who attempts this feat has engaged in "folly" and "presumption". Supra at 423.

The distortion in returns to capital and labor creates a capital gap between the amount of capital needed to maintain an economic growth rate and the capital available for investment from the existing economy. Greater and greater levels of government intervention in the form of incentives are required to overcome the cumulative effects of this capital gap in investment funds to sustain growth. If the subsidized firms export their profits, and if workers are too poor to save, then the most likely source of capital to overcome the gap is tax revenues.

In the earlier years of North Carolina's industrial recruitment history the capital gap was not significant and could be readily met by infusions of incentives from private sources. As the capital gap worsened industrial recruiters began searching for new sources of revenue.

When the government uses property taxes, as in the case of Winston-Salem or Forsyth County, or income taxes, as in the case of the Governor's Incentive Fund, it violates the constitutional prohibition on the use of public funds for private purposes. Tax dollars are given to private firms in an economic process that acts to perpetuate both the lack of domestic surplus capital and to permanently depress the economic welfare of its citizens.

The source of revenue for incentives has shifted in recent years from private sources to public sources. This Court is asked to determine whether any taxpayer should be forced to support an economic policy whose major economic outcome is a government-induced barrier to the higher wages and incomes only optimized in a free competitive market.
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SECTION III. POLITICAL FAVORITISM IS AN INHERENT BYPRODUCT OF THE SYSTEM OF GOVERNMENT RECRUITMENT INCENTIVES
In his 1995 book, Trust, social scientist Francis Fukuyama writes:

"In Europe and Latin America, by contrast, governments have found it almost impossible politically to dismantle sunset industries. Rather than helping to accelerate their decline, European governments nationalized failing industries like coal, steel, and automobiles, in the vain hope that state subsidies would make them internationally competitive. While paying lip-service to the need to shift resources into more modern sectors, the very democratic character of European governments led them to give in to political pressures to direct government subsidies to older industries, often at tremendous cost to taxpayers. There is no doubt that something similar would happen in the Unites States if the government got into the business of handing out "competitiveness" subsidies. Congress, responding to interest group pressure, could be relied on to declare that industries like shoes and textiles, rather than aerospace and semiconductors, were "strategic" and thus worthy of government subsidization. Even in the hightech area, older technologies are likely to carry more political clout than ones under development. Thus, the most compelling argument against an industrial policy for the United States is not an economic one at all but is related to the character of American democracy." Id. at 16.

This brief does not argue that the Winston-Salem/Forsyth County situation involves actual political favoritism. What it argues is that the process of government recruitment incentives inherently creates a condition in which favoritism (i.e., invidious discrimination) is inevitable.

When government selects the recipients of incentives it overrides consumer sovereignty of free choice in the market place. The government substitutes its own judgement in place of the collective, autonomous, free decisions of the market on what type of goods and services should be produced. Any such judgment by the government is inherently arbitrary and capricious because it is neither bounded by legislation nor constitutional constraints, nor is it available to all those similarly situated.

The government has no way of determining the social advantages of its decision. But its decision creates winners and losers, many of whom cannot be identified in advance. The power to decide who gets the incentive is perfectly symmetrical to a power to deny an incentive, or to provide a disincentive to a private firm considering location in North Carolina.

The North Carolina Center for Public Policy Research examined this element of industrial recruitment in a 1985 study titled "Phantom Jobs--New Studies Find Department of Commerce Data to be Misleading." This study found that about 39% of the new jobs publicly promised by private firms from 1978 to 1984 never materialized. The report concluded "We do believe that the deception of economic growth in terms of jobs available is significant to the citizens of North Carolina." Bill Finger, "Phantom Jobs", N.C. Insight, Volume 8, No. 3-4 (April 1986) pp. 50-52.

In another study on the phenomena of phantom jobs, researchers from North Carolina State University reviewed the period from 1971 to 1980. They found that only 47% of the announced new jobs in that time period had actually materialized by 1986. Id. AT 50.

Even if jobs could be guaranteed, industrial incentives to secure them are poor economic policy. In addition to the distortion of market equilibrium these incentives cause economic waste. James M. Buchanan explained in Constitutional Economics at page 39.
"What is rent-seeking?

The basic notion is a very simple one and once again it represents the extension of standard price theory to politics. From price theory we learn that profits tend to be equalised by the flow of investments among prospects. The existence or emergence of an opportunity for differentially high profits will attract investment until returns are equalised with those generally available in the economy. What should we predict, therefore, when politics creates profit opportunities or rents? Investment will be attracted toward the prospects that seem favourable and, if output' cannot expand as in the standard market adjustment, we should predict that investment will take the form of attempts to secure access to the scarcity rents. When the state licenses an occupation, when it assigns import or export quotas, when it allocates TV spectra, when it adopts land-use planning, when it employs functionaries at above-market wages and salaries, we can expect resource waste in investments to secure the favoured plums.

Demands for money rents are elastic. The state cannot readily give money away' even if it might desire to do so. The rent-seeking analysis can be applied to many activities of the modern state, including the making of money transfers to specified classes of recipients. If mothers with dependent children are granted payments for being mothers, we can predict that we shall soon have more such mothers. If the unemployed are offered higher payments, we predict that the number of unemployed will increase. Or, if access to membership in recipient classes is arbitrarily restricted, we predict that there will be wasteful investment in rent-seeking. As the expansion of modern government offers more opportunities for rents, we must expect that the utility-maximising behaviour of individuals will lead them to waste more and more resources in trying to secure the rents' or profits' promised by government."
The concept of economic waste caused by "rent-seeking" is further explored by Gordon Tullock in "The Backward Society: Static Inefficiency, Rent-Seeking, and the Rule of Law" found in The Theory of Public Choice-II. ed. James M. Buchanan and Robert D. Tollison (University of Michigan Press 1984) and found in the Appendix.

A principle beneficial effect of the free market system is to minimize the need for politicized control over economic decisions thus preserving the character of American democracy. Fukuyama, supra at 16. Our constitution prohibits the routine intrusion of government upon the everyday affairs of the citizen. These two systems (free market and constitutional), working in tandem, create for the individual citizen great opportunities for achieving wealth and political freedom.

The intervention of the government using tax dollars in schemes that create financial benefits for a private firm is directly contrary to the provisions of North Carolina's constitution prohibiting exclusive emoluments and privileges and prohibiting expenditures for other than public purposes.

John Locke Foundation, Inc. asks this Court to declare that G.S. 158-7.1 on its face (and as applied in the Winston-Salem/Forsyth County context) contravenes these constitutional prohibitions.

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Conclusion


Cash (and other targeted) incentives provided by government by private firms do not promote the common good. They do not serve a public purpose. By definition they are exclusive emoluments or privileges.

The Trial Court was correct in holding that G.S. 158-7.1 which authorizes these incentives violates basic constitutional safeguards.

Respectfully submitted this the 4th day of January 1996.

STAM, FORDHAM & DANCHI, P.A.

By:
[signature]
Paul Stam, Jr.
Attorney for John Locke Foundation, Inc. P.O. Box 1600
Apex, North Carolina 27502
(919) 362-8873

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