California Ends Unenterprising Economic Development Zones

July 3, 2013

At the end of last week, California’s state legislature passed AB 93, which eliminates California’s decades-old Enterprise Zone Program, which is described as “special incentives designed to encourage business investment and promote the creation of new jobs” in “economically distressed areas.” The repeal bill passed the legislature by large margins, and it is expected that the governor will sign it.

Area-specific tax incentives like this one became popular during the 1980s as a kind of innovative, tax-cut-based economic development tool. We have written on the problems of enterprise zones before, but the California experience serves to strengthen the case against this kind of tax favoritism.

Primarily, these tax policies are distortive. They encourage companies to move away from areas that have many high-skilled workers and better infrastructure in order to hire workers in low-skilled areas with worse infrastructures. This is inefficient, and not likely to be the best use for those resources.

Beyond that, these programs create new, powerful interest groups. The enterprise zones have their own association lobbying for them with strong incentives to press the government for more tax favoritism. The public choice problems of having special tax incentives go to special zones (and, thus, to certain state voting districts) are enormous, as politicians in those districts face re-election concerns if they ever attempt to discontinue those tax preferences.

Paradoxically, if these programs actually encourage development then, by definition, they should eventually render themselves unnecessary. If special development zones make people better off (even if they do it by inefficiently funneling taxpayer money through a distortionary and lobby-rife process), then they should invalidate the poor economic conditions that necessitated their implementation in the first place.

In California, many of these incentives (sometimes totaling over $30,000 per worker) now go to businesses in San Francisco, one of the wealthiest cities in California. The Wall Street Journal reports that Dandelion Chocolate, an upscale chocolate factory, is planning to apply for up to $100,000 in tax incentives this year. What began as a tax credit for poor areas has become, at least in this case, a subsidy for rich cities and boutique goods.

Californians should be glad that the enterprise zone program is being repealed. Although State Tax Notes reports (subscription required) that the program retains a hiring credit, the repeal of a flagship distortionary incentive is a good sign for the Sunshine State.

Read more about California here.

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