Federalism as protection racket.

Forty-eight years ago Justice Brandeis made his famous comment praising the American arrangement of semiautonomous states within a federal system as an incubator of progressive government: "It is one of the happy incidents of the federal system that a single courageous State may . . . serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country." Sadly, recent economic and political trends have stood Brandeis's argument on its head. State autonomy in the economic sphere, which he supported as progressive, has become one of the most reactionary influences on contemporary public policy.

The reason is the competition for industry in which most governors and legislatures feel compelled to engage—either for the economic survival of their states, or for their own political survival. Since large industry is dominated by national and multinational corporations, business people have convinced politicians that while state lines are fixed, capital is entirely mobile. According to this widely held view, among the factors that most influence where that mobile capital will come to rest are the level and structure of state taxation; the degree of union activity within a state; and state regulatory policy in areas from pollution control to employment rights for the handicapped.

In terms of Brandeis's metaphor, the states still exist as separate laboratories, and they retain the legal right to experiment that he helped win for them in the 1930s. But the right is atrophying because the experimental subjects — private businesses—have convinced state officials that corporations will flee their jurisdictions rather than submit to any innovative efforts to regulate their activities or redistribute their wealth. Trying “novel economic and social experiments” in this context is like trying to isolate carcinogens in a Walt Disney movie, with the talking rats telling you to stuff your saccharine because they can get all the sugar they want in the nice laboratory across the street.

Unlike Brandeis's experiments in progressivism, which he believed could be conducted “without risk to the rest of the country,” today's state experiments in reaction are explicitly intended to penalize the rest of the country. The purpose of giving tax and regulatory breaks to businesses is to entice them away from other states, or at least to hold onto your own in the face of other states' enticements. A recent article in the Boston Globe noted the satisfaction felt in Massachusetts because a new state agency had used tax-exempt bonds to bribe a national retail chain to move 209 jobs to Boston. Local pride at this accomplishment seemed undiminished by the fact that the jobs in question came from the South Bronx.

If tax rates, environmental standards, and labor rules were all set nationally, as they are in other industrialized countries, business would not be able to pit the different states against one another in this way. The tradition of state autonomy in such matters is supposed to preserve a degree of local freedom within our national system. But the mobility of big business makes this freedom somewhat illusory; the states clearly would be much better off if some of these policies were set nationwide. The states are prisoners of their own freedom. In 1976 Massachusetts voters defeated a proposal calling for flat electricity rate, to end the practice of volume discounts for large industrial users. They were persuaded that it would be economically suicidal for one state to impose such a rate structure by itself. But a year later, when the US House of Representatives put a similar proposal into its version of the 1977 energy bill, the provision was eliminated in conference with the argument that such a national policy would invade an area reserved for the states.

Most economists with whom I have discussed this problem contend that there's a flaw in the basic thesis. They say that the business community greatly exaggerates both how mobile industrial and commercial activity really is, and how much differences in state policy influence decisions about where to locate. State-imposed costs are usually a small part of the overall cost of doing business. Consequently, even 20 or 30 percent differences in these costs from state to state show up as very small blips on a corporation's fiscal radar screen. I'm convinced we can afford to be skeptical about the need to let corporate wishes shape state policy. Unfortunately, few other state officials share that skepticism. The perception that states must either adopt "pro-business" policies or suffer serious economic harm is one of the dominant influences on policymaking in much of the country, and particularly in the industrialized Northeast and Midwest.


STATE OFFICIALS HAVE been impressed—some even alarmed—by the significant shift of economic activity in the United States away from the Northeast and Midwest to the South and Southwest. There are complex reasons for this trend; I do not believe that industry was driven from snowbelt to sunbelt by unsympathetic state governments. But the critical political fact is that this shift of jobs and capital in a south and southwesterly direction was also, in general, a shift away from states with higher taxes, more nearly adequate welfare and unemployment compensation benefits, and tougher economic regulatory policies; and toward states with lower levels of taxes, benefits, and regulation. Many have reasoned, post hoc ergo propter hoc.

The effect of this on public policy is clear to see. First, it is one of the main reasons that the real incomes of welfare recipients have been falling, and will almost certainly continue to fall. The first demand of the business community in snowbelt states is for reductions in state and local spending. This usually means cutbacks in spending on human service programs. For one thing, welfare and related programs are among the largest items in any state's budget, making them a tempting target. Second, welfare recipients—especially the non-elderly—are always politically vulnerable, and especially so in today's conservative climate. Business leaders who demand reduced state spending may not wish to see welfare recipients hurt, but they rarely participate in efforts to find more humane budget cuts. Most state budgets contain plenty of socially unuseful spending, reflecting the political needs and preferences of elected officials. The corporate community in most states —while insisting on budget cuts—seems perfectly willing to leave the politicians on their own in deciding where to cut.

The second major effect of the business community's pressure on the states is to make state tax structures less progressive. In addition to pressing for generally lower spending and tax practices, the business community has demanded a disproportionate share of tax relief for itself, in both its corporate and its individual capacities. This campaign began with efforts to reduce corporate tax rates, and to abolish or severely reduce taxes on business inventories and sales taxes on machinery. Soon states began to offer special tax incentives to corporations willing to move in from outside, as well as to those undertaking expansions within the states where they were already located States have used their rights to sell federally tax-exempt bonds to help finance corporate expansion. And special state tax credits and deductions for firms adding to their employment rolls or productive capacity have also become widespread.

These reductions have done more than simply reduce the amount of money available for general government purposes. These tax concessions to businesses have helped bring about the public mood that has brought us Proposition 13 and its imitators. The proportion of state and local taxes paid by individuals has increased sharply as a consequence of the reductions offered to corporations. As Bob Kuttner wrote in the Washington Post “the tax revolt in 1978 was created largely by business tax relief at the expense of homeowners.”

Tax relief for corporate entities has waned in popularity recently as some economists have attacked the economic assumption on which it rests, pointing out how small a part of business expense state taxes represent. But in its stead has come an explicit demand by the business sector and its allies that individual taxation m the states be made less progressive than it now is (usually not very progressive). This argument is used most effectively in the northeastern states, which want to replace heavy manufacturing with economic activity more suited to their climates, lack of energy sources and resources, and remoteness from transportation lines. This sort of activity—for example, high technology manufacturing and major financial institutions—employs fewer people than auto-or steelmaking, but pays significantly higher wages to those it does employ.

Since they use relatively little in the way of raw materials or energy, labor costs are a major concern to these firms, and their argument is that the high cost of living in the northeastern states forces them to pay uncompetitively high wages to attract the employees they need. The solution, these states are told, is to reduce taxes in the higher brackets, so that young engineers and managers can afford to live in the Northeast.

This focus on the economic plight of middle management and high technology manufacturing employees creates another potent second order effect. It makes it unlikely that much will be done on the state level to alleviate the plight of big cities. One of the most serious causes of urban distress in Massachusetts, for example, is our disastrously high rate of property taxation. For years it has been the goal of most students of the state's economy to lower these rates, which have their most pernicious social and economic effects in older, larger cities. Some real gains were made in this direction in the past five years, but they are now endangered by the view that economic salvation rests with continued development of computer industries—which are located almost exclusively in the suburbs.


THE THIRD IMPACT of the competition for industry is in the regulatory area. Environmental rules, consumer protection, protection of employment rights for minorities, pregnant women, gays, and the handicapped, all face very serious political obstacles today from corporate leaders who threaten to move out of the state if they are hedged in with any more restraints. This happens in both the industrialized states, which seek to stop their economic losses, and in the sunbelt, where it is argued that regulatory policies that might discourage new arrivals must be avoided. Many of the changes we expected to accompany increased industrialization in the South and Southwest have been thwarted by precisely this tactic. The most glaring example relates to labor unions. One of the major advantages enjoyed by the sunbelt states, according to business leaders, is their relative freedom from organized labor; and the southern and southwestern state governments have worked hard to keep things this way. “One thing that attracts business to the state is the fact that we don't have many labor unions,” one North Carolina state senator said in opposition to a proposal he saw as a threat to his state's economic growth. The proposal in question was not to change the state's labor laws, but simply to open what the New York Times described as “a center for labor education and research” at North Carolina Central University. The Times went on to report that his opposition to this effort was widely shared by other legislators, in response to overwhelming opposition from the North Carolina business community.

The only way to prevent the interstate competition for industry from continuing to exert a powerful downward pull on public services is to reassert the moral and economic case for a strong federal government. This does not mean an end to state policy freedom. It does mean that as long as certain critical national policy questions—such as income transfer policy, and the right of labor to bargain collectively— are left substantially to the states, these questions will be decided not on their merits but on the basis of corporate blackmail.

Of course tax reduction is not automatically an illegitimate policy choice, and those who wish to reduce further the real incomes of welfare recipients have every right to make their case. But these policies ought to have to be defended on their merits — that is, on the basis of some notion about how our national resources should be divided between the public and private sectors. Today, in state after state, the debate is rigged. The argument that carries the day is simply that we can't afford to be nicer to the poor than Texas, nor more progressive in our tax structure than New Hampshire.

A few simple reforms would solve the problem: A national welfare plan, and uniform levels of unemployment and workmen's compensation benefits (suitably adjusted for regional living cost differences); a uniform national policy toward labor unions; an end to the use of federal tax subsidies and exemptions by states seeking to lure away one another's industry; a comprehensive national health plan. These are the essential elements of a national policy that would preserve legitimate state autonomy over a very wide range of issues, without allowing the business community to use the leverage of its real or pretended mobility to impose its particular conservative policy preferences, justice Brandeis was right in his day. But today his laboratories are acting more like massage parlors.

This article appeared in the December 29, 1979, issue of magazine.