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Competition spawns incentives

By Dan Trigoboff
Business editor

December 05, 2004
The incentive package that enticed Dell Inc. to come to North Carolina had state Rep. Rick Glazier thinking about the nuclear arms race.

Glazier said he would like the use of such packages to be scaled back. But for North Carolina to do so, he said, would be equivalent to unilateral disarmament, something the state cannot afford.

If a large company is in play, he said, and other states are building incentive packages ''as a matter of law, our job is going to be to create the best economic assistance we can."

However, he added, North Carolina is ''never going to be able to win in this tax-credit and tax-incentive game."

With no moves away from incentives by elected governments, Glazier - a lawyer and law professor from Fayetteville - is looking to the courts.

Toledo's package

Only weeks before the Dell deal's approval in November, the 6th U.S. Circuit Court of Appeals in Cuno v. DaimlerChrysler struck down as unconstitutional a $280 million incentive package used in persuading DaimlerChrysler Corp. to expand in the Toledo area. That decision makes uncertain for many states the legitimacy of their own tax-based incentive plans.

The court found that use of the state's taxing authority discriminated against interstate commerce by giving preferential treatment to in-state investment and commercial activity.

Decisions of the 6th Circuit, which covers Kentucky, Michigan, Ohio and Tennessee, are not controlling in North Carolina. But the case sent a chill to those seeking to use tax authority to build incentive plans.

State legislative staff said in a memo shortly after the decision that ''many of North Carolina's tax incentives would potentially be affected by a ruling applicable in this jurisdiction upon reasoning similar to that laid out in the Cuno decision."

''It's a very significant case," said Washington lawyer Charles Rothfeld, who represented DaimlerChrysler in the Cuno case. ''At least 40 states offer some kind of tax-based incentives."

Bill Martin, president of the Cumberland County Business Council, whose job is to attract business, said the Ohio case ''leaves me with a feeling of uncertainty. It's got some wide-ranging ramifications."

DaimlerChrysler has asked the 6th Circuit for a rehearing, and government entities involved in the case say they will take it to the U.S. Supreme Court if necessary. Such a move could set a national precedent.

U.S. Senators George Voinovich and Michael Devine, both Republicans from Ohio, quickly introduced a bill designed to overrule the Cuno decision. The bill is in the Senate Finance Committee.

The U.S. Constitution gives Congress the job of regulating interstate commerce. But Congress has not acted on issues presented in the Cuno case, lawyers say.

In the absence of congressional action, courts can determine that a state or local law is an unconstitutional burden on interstate commerce under what's called the ''negative" or ''dormant" aspect of the Commerce Clause.

Possible legal action

In North Carolina, at least two legal groups are considering challenging the Dell incentive package. The North Carolina Institute for Constitutional Law, headed by former state Supreme Court Justice Robert Orr, and the North Carolina Justice and Community Development Center are considering suing to stop the incentives.

Orr's opposition to economic incentives like the package given Dell is longstanding. During the recent political campaign, his criticisms of publicly backed incentives were often cited in opposition to Amendment One. That ballot initiative, which won passage in November, was intended to broaden local government's ability to raise money to recruit businesses to their communities.

Both associations also are considering legal action in opposition to the enactment of Amendment One, but those issues are more likely to deal with election law. Both groups say the initiative's ballot presentation was misleading.

In 1996, Orr wrote the dissent in what is considered the leading North Carolina case on the subject of tax-supported incentives, Maready v. Winston Salem. Then, as now, Orr questioned whether tax-supported economic incentives provided for businesses met the state Constitution's requirement that taxation be used for a public purpose.

In the Maready case, Orr wrote that ''the assumption that new jobs and a higher tax base automatically result in significant benefit to the public" for the purpose of using the state's taxing authority was ''a fallacy," absent evidence that incentives paid or committed improved the employment rate or ''resulted in meaningful economic enhancement."

The Maready case flipped the definition of public purpose, Orr said last week. Historically, he said, the primary benefit of the public expense was to the public, not to a company or individual.

Under current schemes, he said, it's the public that gets the tangential benefit. The direct benefits, he said, are for the recruited companies.

Orr also said that granting benefits to some companies and not others violates state constitutional standards of equal protection.

''Even if you assume that the creation of jobs is a public purpose," Orr said, ''can the government use its taxing power to favor a handful of these large businesses, when the bulk of businesses get nothing?"

Jack Holtzman, staff attorney at the Justice Center, said, ''We consider this an issue of corporate welfare. We don't believe that corporate welfare giveaways such as Dell and Merck fall within public-purpose analysis." Merck & Co. was given a $36 million incentive package late last year.

On the issue of equal protection under the law, Holtzman said the incentives package given Dell and other companies does not appear to be an equitable and fair distribution of government resources. Both issues, he said, are being researched for possible litigation.

In the Cuno case, the appeals court struck down arguments relating to public purpose and equal protection. The court found that the tax-incentive plan's benefits were related to economic development of blighted areas.

Cumberland County

Here in Cumberland County, Martin said, ''we still love all businesses equally. But certain types of businesses will be encouraged more through incentives. We would give incentives to a manufacturer as opposed to a small retail business. A manufacturer selling all over the nation and the world is going to pump new money into the economy. That's how you grow the economy. Manufacturing jobs pay about three times what retail jobs pay. The retail market grows automatically because of growth in the economy. Certain sectors get incentives because they have a larger impact, a more direct impact on the economy."

On Thursday in Raleigh, Orr's Institute for Constitutional Law is hosting a continuing legal education program on the constitutionality of economic incentives. In addition to Orr and Holtzman, the program will include Peter Enrich, a Northeastern law professor who was lead plaintiff's lawyer in the 6th Circuit case; William Maready, a lawyer who was the plaintiff in the Maready case; and Ernest Pearson, a lawyer who supported the pro-incentive side in the Maready case.


A successful state challenge to an incentive package such as Dell's in North Carolina courts would force the ''unilateral disarmament" Glazier fears.

Martin agreed. ''Any such restrictions that apply only to North Carolina would put us at a distinct disadvantage," he said.

Without the incentives, Martin and Glazier say, North Carolina and the Fayetteville area could market themselves based on available labor, availability of land and utilities, transportation, proximity to markets and other positive factors.

''In general," said Martin, ''if you asked almost any economic developer, he would prefer to sell his community on its own merits, without having to use incentives. But it's a very competitive business. If somebody offers incentives, somebody else is going to offer something to offset that." Unless, he noted, such incentives are prohibited.

But Orr remains unconvinced that unilateral disarmament would assure destruction of the state's business competitiveness.

''Surely the leadership of this state is imaginative enough to come up with a use of comparable tax dollars to increase the attractiveness of the business community in North Carolina," he said. "The idea is to build a more attractive business community across the board, not just giving out millions to a wealthy few." The incentive plans at issue, he said, ''are simply not the only - nor do I think the best - way to develop our business base."

Enrich, the lead plaintiff's counsel in the Cuno case, said his involvement began with a lengthy law-review article he wrote years ago and a conversation with Ralph Nader. The well-known consumer advocate and unsuccessful presidential candidate read the article, Enrich said, "and asked me, 'Can we litigate?' "

Drawing a line

The 6th Circuit, Enrich said, is ''drawing a line very sensibly. Some state is going to get that facility. Dell is going to locate that facility somewhere." But, he added, when a particular state uses the tax system to distort economic decision-making, the ultimate losers are all of the citizens of all of the states. We're all undermined if you let states compete over interstate commerce."

Martin disagreed. He said incentive packages can sometimes be used to offset labor cost advantages for companies considering a move to another country.

In its ruling, the 6th Circuit suggested that governments might avoid the constitutional problems by giving the companies direct subsidies. DaimlerChrysler argued that there was no difference between subsidies and tax-based incentives, Rothfeld said.

But while they might look the same to an economist, Enrich argued, the difference is night and day. And the court said that subsidies "do not ordinarily run afoul of the Commerce Clause because they are not generally connected with the State's regulation of interstate commerce."

Area advocates Glazier and Martin believe that companies might prefer direct incentives, particularly cash. But they also say that it would be harder to sell the deals politically.

''But I'm not sure that's a bad thing," Glazier said. ''We wouldn't get to hide behind credit packages. It would force to the table a fuller discussion."

Still, he believes the tax schemes have economic advantages. ''When you're talking about cash, you're talking about direct outflow, an amount directly out of an existing resource. With Dell, the credit is against income that doesn't exist. It's a credit against future income."

Tax subsidies, said Martin, come out of new wealth. And, ''if a company goes to Tennessee, North Carolina's not going to get anything."

Enrich said there are clearly contributions government can make in recruiting businesses without offending the Constitution. Subsidization of worker training or utilities, he said, can clearly favor in-state residents without violating the Commerce Clause.

It's called '''the market-participation exception," Enrich said. ''Governments can provide services specifically to local residents. Governments can operate services, like schools, and offer them just for state citizens. There just has to be some common sense."