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What's Wrong
with Silicon Subsidies?

Citing Silver State diversification needs, a PAC is once again pushing to change the state constitution to okay corporate welfare. Here's why a state-run venture-capital fund won't work — and what will.

by D. Dowd Muska

an a joint resolution overwhelmingly approved by the Nevada Legislature in two consecutive sessions actually spell trouble for Silver State taxpayers? While some may find it hard (and others, easy) to believe, such is the case with SJR-12. Passed by both houses in 1997 and 1999, the resolution will go to voters as ballot Question 1 in November. If passed, the state government will soon offer venture capital (VC) to high-tech entrepreneurs.

A political action committee (PAC) comprised of establishment business groups, politicians, union bosses and educrats is attempting to convince voters to approve Question 1. And the organization isn't letting any inconvenient ideas about the proper role of government get in its way. The PAC wants to repeal "out-dated language in the Nevada constitution" which causes the state to lose out "to its neighboring states in the competition for new business." If only Nevada could legally invest general-fund revenue in "prudently managed investments in public-private partnerships and corporations" (to use the language of SJR-12), the state would be "competitive with other states in providing the necessary financial tools to attract the types of businesses and industries that would diversify the economic base."

Backers of Question 1 list "low-interest financing to builders for senior and low-income housing" as one possible result of the measure. In actuality, federal, state and local funds already do that in Nevada. It's clear that the backers' main goal is an expansion of Nevada's pathetically small technology industry. They believe that since so few venture-capital firms exist in the state, taxpayers should pick up the slack. But in their zeal to make Nevada a "Silicon Oasis," the pro-subsidy crowd has lost sight of the vital distinction between the private and public sectors. If it passes, Question 1 will do little to expand the high-tech industry in Nevada—but it will expand the state's voracious corporate-welfare apparatus.

Public Dollars, Private Benefit

Time investigative reporters Donald L. Barlett and James B. Steele define corporate welfare as "a game in which governments large and small subsidize corporations large and small, usually at the expense of another state or town and always at the expense of individual and corporate taxpayers." It's best to think of corporate welfare in two classifications, "hard" and "soft." The former is most often found at the federal level. Marketing subsidies for export businesses and research grants to politically savvy companies are examples. Soft corporate welfare isn't payments, but indirect giveaways such as tax breaks and low-interest and/or government-backed loans.

Estimates vary, but each year the federal government needlessly subsidizes corporations, in both hard and soft forms, to the tune of perhaps $125 billion. No reliable figures exist for the cost of subsidies from state governments. In fact, corporate welfare at the state level often escapes serious scrutiny. It shouldn't. What Barlett and Steele call an "internecine, multibillion-dollar battle for jobs" has waged between the states for decades. The conflict started in 1936, when Mississippi began to grant benefits to Northern manufacturers willing to relocate their plants south. (Although Mississippi started the competition at the state level, it was and remains the poorest state in the union.) Today, every state has at least one agency charged with fostering "economic development." Empowered by legislators with more and more resources, these bureaucracies are getting increasingly aggressive, and many have begun to shift from soft to hard corporate welfare.

Economic-development schemes are often sold as market-oriented tools. Pols and bureaucrats like to describe such arrangements as "public-private partnerships." (Question 1 uses the term as well.) It's sensible to use public funds to help businesses, supporters say—just look at the return we're getting! Each new business that moves to our state or expands its existing facilities helps our economy and tax base. How can creating more jobs for our citizens be wrong?

That's a shrewd argument, but one easily refuted by rudimentary economics. No matter how much free-market rhetoric is slathered on economic-development projects, in reality they are a dressed-up combination of two very old-and discredited—policies: pork and central planning. Governments do not produce but merely redistribute wealth, so economic-development schemes do not "create" jobs. Since corporate welfare substitutes political considerations for the wisdom of individuals engaged in voluntary exchanges, it warps capitalism in fundamental ways.

One of corporate welfare's most damaging consequences is the advantage it hands to its beneficiaries, at the expense of their competitors. As libertarian author and government watchdog James Bovard puts it, "Government cannot help one industry or business without indirectly disadvantaging all others."

Michael LaFaive, of the Mackinac Center for Public Policy, agrees: "It is poor economics and fundamentally unfair for government to pick winners and losers by providing special breaks, favors, or subsidies to certain firms and not their competitors."

The negative effects of subsidies are easy to grasp, but as LaFaive noted, even seemingly innocuous tax breaks come with a cost. When a corporation receives a special tax deduction or abatement, the revenue lost must be replaced. After all, governments do not cut spending each time they bestow such a perk. So it is up to others to make up the difference.

The Future of Freedom Foundation's Sheldon Richman offers an additional criticism of soft corporate welfare:

It is wrong to believe that government manipulation of business through tax advantages has no cost. To the extent that manipulation brings about investments that would not have occurred naturally, the loss consists in the investments that would have been made but were not. Those forgone opportunities would have created jobs and products that will never be realized. That is a loss, although it isn't entered in the ledger.

One need not rely on mere economic theory to conclude that government giveaways to businesses are wasteful. In Nevada and across the nation, the record of corporate welfare is well-documented. The federal government's history of funding high-tech research is bleak, and its price-support programs for agribusiness make consumers' grocery bills higher. The opening salvo in the corporate-welfare war at the state level was itself a failure—despite the incentives it received, the first manufacturing plant lured to Mississippi in the 1930s soon went out of business.

In Nevada, corporate welfare has a unique justification: It is seen as a means to diversify the state's one-industry economy. But the Nevada Commission on Economic Development (NCED), which oversees the incentives the state gives to non-casino companies to relocate to or expand in Nevada, has not affected the state's non-gaming versus gaming proportions. In 1980, employment in resorts and the service sector comprised 42.3 percent of all jobs in the state. In 1996, after the NCED had been on the job for 13 years, that the figure had risen—to 43.2 percent. Yet individual and corporate taxpayers in the Silver State picked up the tab for millions in tax breaks the agency doled out. And government-backed diversification debacles aren't limited to the state level. As Las Vegas Review-Journal correspondent Trevor Hayes recently reported, after 15 years in operation the Las Vegas Technology Center, a city-funded project designed to attract technology businesses, has "just one high-tech company."

The Hard Drive

It's rare to walk into a conference room at a Nevada hotel these days that isn't hosting yet another "working group" or "government-industry panel" gabbing about how to bring high-tech to the state. Of course, these meetings aren't confined to Las Vegas and Reno. As the San Francisco Chronicle's Mark Simon noted a few years ago, "All over the world ... communities and people want to glom onto Silicon Valley, not just for the economic prosperity but for the glamour and sophistication that come with it." Governments have thrown piles of money at schemes designed to transform their regions into the next hot technology hub. Reason's Virginia Postrel described the monolithic thinking behind such behavior in a recent column: "We know the one best future, and it is 'high-tech.'"

If the infatuation Nevada's economic-diversification crowd has with technology is hardly original, its motivations have to be respected. Many of the advocates are longtime Nevada residents who are proud of their state, whatever its flaws, and want a better quality of life for their fellow citizens. And growing Nevada's high-tech sector would certainly bring that about—according to the American Electronics Association (AEA), the average salary for a U.S. high-tech worker is $53,000. That's well above the average salary of a private-sector worker in the Silver State, a figure which doesn't even crack $30,000.

Nevada's high-tech-through-state-dollars cheerleaders stand on intellectual quicksand, though. The consequences of state soft-core corporate welfare can't be evaded. But instead of seeing the NCED's ineffectiveness as a reason to get out of the economic-development subsidy game, they just want state government to do more.

The strange-bedfellows alliance pushing for a state-run VC fund is pouring a lot of resources into the attempt to pass Question 1. Deriding the anti-investment clause of the state's constitution as "a carryover from the 19th century," Nevadans for Equal Opportunity (NEO), their PAC, is attempting to convince citizens to vote for a measure quite similar to measures voters rejected in both 1992 and 1996. If the third time's a charm for NEO, Nevada's technocrats will finally have a slush fund they can dole out at will.

What Nevada Hath Wrought

But diversification supporters couldn't have picked a worse Nevada industry in which to invest their hopes for non-casino economic growth. The Silver State's high-tech community is tiny—for good reasons we'll get to in a moment. Only 20 out of every 1,000 private-sector workers are employed in the state's technology sector, according to the AEA. That's 45th among the 50 states. Last year the Progressive Policy Institute ranked Nevada 35th or worse in categories such as patents and R&D investment. Only one state had a lower percentage of civilian scientists and engineers in its workforce.

Those are pretty depressing statistics, but according to NEO, Question 1 will give state government the power to turn Nevada's high-tech frown upside-down. If recent history is any guide, the group's hope is misplaced. The State of Nevada, like most bureaucracies, is not adept at navigating the complexities of high technology. Both the state's welfare and motor-vehicle divisions are infamous for long-running gigantic computer debacles. Legislators have signaled their ignorance of and hostility to the Information Age on multiple occasions, most notably, perhaps, when they passed an unconstitutional and unnecessary anti-spam law in 1997. Many state officials continue to incorrectly insist that Nevada has the right to tax out-of-state online purchases by its residents.

Considering the fact that few in state government have any background in high tech, such actions should be no surprise. As one Nevada businessman with extensive experience in Silicon Valley observes, "Is there any elected ... official who has an in-depth background in 'high-tech' industry, or even 'medium-tech' industry? No. Is there anyone in the [NCED] ... that has any useful background in technology industry? No. Has the NCED or any related agency had much success in attracting or helping to start technology-based industry within the state? No. The bottom-line answer is that unless a person has 'been there and done that' there is no way that they can have 'a strong understanding of the high-tech industry,' or any other industry in which they have not done time."

Lack of experience is not the only reason Nevada technocrats would face very long odds in attempting to identify promising tech ventures. Economists James W. Gwartney and Richard L. Stroup, authors of the primer What Everyone Should Know About Economics and Prosperity, explain:

If the [private] investor makes a mistake—if the investment project turns out to be a loser—he or she will bear the consequences directly. In contrast, the link between the selection of productive projects and the personal wealth of the central planners will be weak. Even if a project is productive, the planner's personal gain is likely to be quite modest. Similarly, if the project is wasteful—if it reduces the value of resources—this failure will exert little negative impact on the planners. In fact, they may even be able to reap personal gain from wasteful projects that channel subsidies and other benefits toward politically powerful groups. Given this incentive structure, there is simply no reason to believe that central planners will be more likely than private investors to discover and act on projects that increase wealth.

Evidently, the NEO folks believe a state-run VC fund will be able to jump over that mountain. Money talks, remember. Subsidization, the PAC says, will jump-start Nevada's technology sector. But is this the strategy that other communities have successfully used to build their technology-based economies? Not really. "The high-tech industries that have sprung up in 'Silicon Valley,' California, and in the Boston area were not the result of government actions," writes Douglas County Center for Economic Development Executive Director Fred Jones. "Both of these geographical high-tech areas primarily developed out of the academic environments existing at Stanford University, M.I.T. and Harvard University (note that these are private universities) and supported by the personal lives, energies and fortunes of a few risk takers."

Jones' words have fallen on deaf ears with Question 1 supporters, who base their faith in a Nevada-run VC fund on a similar creature in the Beehive State: the Utah Technology Finance Corporation (UTFC).

Oops

NEO promotional literature proposes the creation of the "Nevada Technology Finance Corporation," modeled after the Utah agency. A faux fact sheet about the fantasied agency ("created by the Nevada Legislature in 1983") extols its purpose, which is to foster "innovation and entrepreneurship in Nevada by providing debt investment in start-up and growing Nevada businesses."

Apparently NEO is unaware that Nevada's neighbor to the east is actually looking to get out of the technology-finance game. The Management Committee of the Utah Legislature recently approved a bipartisan plan to privatize the UTFC, a move strongly endorsed by the Salt Lake Tribune:

If state government is interested in promoting technology-related business as well as other enterprises, the best way for lawmakers to do this is to create a climate congenial to it. This is best done by eliminating unnecessary and stifling regulation and by employing tax policies that do not discourage economic risk-taking in the private sector; it is not done by getting into the loan business.

As for the UTFC's role in producing Utah's tech sector, Forbes reporter Suzanne Oliver found that the state's high-tech boom started not from central planning, but "spinouts from Brigham Young University's computer science department, including WordPerfect, Novell and Ameritech Library software."

Certainly all the goodies that communities seem willing to shower on high-tech companies can tempt some executives in the industry to play along. But others have started to have second thoughts about the flirtation with government. They've watched as the U.S. Department of Justice has targeted Microsoft and Congress has passed unnecessary federal regulation of encryption technology and online privacy. They've also watched states pass many laws which stifle high-tech innovation. As a result, a large group of technology companies—led by Cyprus Semiconductor CEO T.J. Rodgers—has publicly denounced corporate welfare. Each member of the crusade has signed the "Declaration of Independence" from government freebies. The document leaves no room for ambiguity:

The high taxes that our company and its employees pay to support the current local-state-federal government tax burden ... hurt our economy more than any possible corporate benefit from government spending. If an independent commission  similar to the military base-closing commission identified a fair and substantial government spending cut in the area of so-called "corporate welfare," I would support that cut, even if it meant funding cuts to my own company.

As Rodgers recently told Investor's Business Daily, Silicon Valley is "about free minds and free markets ... . Washington's the exact opposite. It is an absorber of wealth, a destroyer of wealth. For us to start playing the pork-barrel game, where we try to lobby skillfully against other sectors to try to get back a proportionate amount of our money, to break even in the pork-barrel game—what a loser's game that is. [If] we go to the government and start whining, pretty soon the government owns enough of us that they start mandating things that we need to do. Pretty soon we have another government-controlled industry."

The aforementioned Nevada businessman with a Silicon Valley background admires the courage of Rodgers and his band of followers, and wonders where the nation's leading-edge technology companies would be if government-run VC funds had been active decades ago:

The two founders [of Hewlett-Packard] ... started HP with only $500, a strong desire to be in business for themselves, a few ideas and a garage. They would have never survived if they had had to submit a long application to a government agency for funding and then awaited a positive decision from some unenlightened individual who knew little or nothing about engineering and could not assess their prospects.

Living in Reality

The sad thing about this particular misguided march toward a Nevada technocracy is that a strong high-tech sector would indeed make the state's economy more solid and its citizens much wealthier. But this development will never happen as long as business and political leaders in the state refuse to face the truth about why Nevada remains a silicon desert.

There are a plethora of reasons why New Economy-style companies should see this state as an attractive place to set up shop. Its proximity to California, mild weather, vast recreational opportunities and lack of personal and corporate income taxes surely tempt many IT entrepreneurs.

So why do so few sprint toward the Silver State? The biggest reason is the dead weight of Nevada's government schools. With a dropout rate double that of the national average, a dismal college-continuation rate and no world-class private universities, high-tech CEOs don't see a lot of potential employees in Nevada's labor pool. From time to time, even Silver State politicians publicly admit that the education situation is a disaster. "We are last in so many things," Gov. Guinn recently lamented. "We need an educated workforce."

But it's not just education that keeps companies away. The state's serious crime problem, growth-related problems and the perception that casino bosses run all three branches of government—all repel businesses from practically every industry.

No reasonable person would disagree with the goal of diversifying Nevada's economy. But it's not up to pie-in-the-sky planners—from the private or public sectors—to determine how that diversification should take shape. Government can certainly play a role in creating a climate where all kinds of companies flock to Nevada. Boosting the quality of education through school choice, attacking growth problems with innovative, market-based solutions and cutting the state's sky-high sales and gas taxes are just a few forward-thinking, nondiscriminatory policies which are sure to make Nevada more attractive to non-casino employers. But these changes require political courage and patience, both of which are in short supply in the Silver State these days. Slick, quick fixes like Question 1 are doomed to fail. NJ

D. Dowd Muska is a contributing editor of Nevada Journal.


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