California Offers $420 Million in Tax Incentives to Military Aerospace Contractors

July 10, 2014

California’s legislature voted this week to offer $420 million in tax incentives to Lockheed Martin in order to locate production of a new stealth bomber in California (specifically at Lockheed’s existing Palmdale facilities). The situation is complicated. Northrop Grumman and Boeing are competing for the rights to the $55 billion stealth bomber contract (Northrop Grumman currently produces stealth bombers) and both have major production operations in California. If Boeing wins the contract, Lockheed Martin, also with large California facilities, will be the main subcontractor for Boeing.

Narrow incentives such as these are not sound tax policy. They rarely succeed in their aims of “creating” jobs, and create major distortions as existing companies foot the full freight of the tax bill in order to provide incentives to other favored firms and new investments. California in particular has been seriously disadvantaged by film credits in other states, and has experienced much debate over its own film incentive program. But the recent incentives for Lockheed Martin illustrate particularly well why narrow tax incentives are not just bad policy, but also ineffective.

The Lockheed Martin deal was only made possible by a compromise promising to offer the same deal to Northrop Grumman if they win the contract. This is the theater of the absurd in tax incentives. California gave the deal to Lockheed in order to give them a cost advantage over Northrop Grumman so they could compete better to get the bomber contract from the Air Force. By offering the same deal to Northrop, California has neutralized its own policy, returning Northrop and Lockheed to exactly the same relative competitive positions as they occupied before incentives. These incentives are just treading water for no reason.

Offering state tax incentives as a way to compete for federal military contracts is peculiar in its own right. In effect, $420 million of the cost of developing the new stealth bomber will be paid by California’s state government. Plus, military contractors have widely-recognized incentives to ensure that production facilities are located in many different states and congressional districts, and can only use facilities that meet certain security guidelines, and their main customer (the government) is financed by taxes anyways, so they can likely easily build taxes into the cost of their product. In other words, military contractors are almost certainly one of the industries with the least sensitivity to state tax policies (along with government employment itself).

Essentially, California has declared that it will offer $420 million to anybody who will promise to build stealth bombers in Palmdale. Northrop Grumman, Boeing, and Lockheed Martin all already have facilities in Palmdale, and have historically worked on stealth fighters and bombers in those exact facilities, so it was always likely Palmdale would be the site of any new stealth production. Just to make it crystal-clear, Northrop Grumman has already announced they will produce the new bomber in California, even before an incentive package has been voted on, so incentives seem particularly unlikely to matter. By offering incentives to both companies already located in the state, California is mostly competing against itself, and doing so at a price of $420 million.

Major aerospace production involves a large number of highly-paid, high-skilled workers, so it’s understandable why policymakers would be tempted to provide large tax incentives, even when those incentives are poor policy. But especially in this case, tax incentives are almost certainly going to result in costs to California’s state government while having next to no influence on where the new bomber will actually be produced (Northrop Grumman, for example, would still locate much of the design and engineering in Florida), while Lockheed Martin or Northrop Grumman get to benefit from California’s robust public services without pulling the same weight as other California companies.

Read more on California here.

Read more on tax incentives here.

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