Kentucky Senator Rand Paul announced his candidacy for President yesterday. One of the central policy proposals in his announcement speech was the establishment of Economic Freedom Zones in economically distressed areas across the United States. To spur business and job creation in these areas, Paul would cut the income and corporate tax rates to a flat rate of 5% , while cutting both sections of the payroll tax to 2% for a period of up to 10 years. He would also exempt eligible businesses from certain environmental and labour regulations. Paul has frequently invoked Detroit as one of the beneficiaries of this initiative, which Paul first introduced in a 2013 speech to the city’s Economic Club.
Economic Freedom Zones for Detroit and other deprived communities is a worthwhile proposal from one of the GOP’s most individual thinkers. With much of the centre-right conversation on poverty revolving around family structure, Paul has staked out a solidly supply-side alternative, focused squarely on the negative externalities of tax and regulation in poorer communities. This emphasis is to be welcomed, however the Zones proposal itself is problematic. It relies on questionable assumptions about how responsive business activity is in response to targeted tax cuts – assumptions which are not borne out even by optimistic assessments of similar schemes.
Some of the background cited in Paul’s Rx for Detroit is incorrect. 47% of the city’s residents are not illiterate, as claimed. This datum is perhaps more shaky than the now largely defunct “47% pay no taxes” equivalent, but there are deeper issues with the Zones as proposed.
Similar initiatives to the Economic Freedom Zones such as Enterprise Zones, Empowerment Zones and Renaissance Zones have had a very mixed track record, with certain exceptions. A key flaw has been their assumption that tax rates are the dominant consideration of firms considering relocating or expanding. Tax rates are likely to be one of several, competing with the quality of transport links, the skillset of the population, public service provision and the strength of the business case for an area. There is a reason why few enterprise zones or tax credits could encourage major tidal power investment in Nebraska, for instance.
When zone-based initiatives do attract employment and investment, this is often simply displaced activity from nearby areas. The worst case scenario for policymakers include high “deadweight” gains: the jobs and investment which would have been created in any event and which governments have subsidised at considerable public cost.
The premise that the disincentives to establishing or expanding businesses in Detroit are simply so great that only substantial tax cuts and regulatory relief can promote this on a wide enough scale has an intuitive appeal. That the city’s challenges are legion is undisputed. Detroit is not however a homogenously decaying city, nor are its socioeconomic problems evenly distributed throughout it. Paul’s proposal differs from earlier incentives which often targeted the city’s hardest hit neighbourhoods in that it encompasses the entire city. This means that companies investing in any area, from the former industrial corridors on the city’s East and Southwest sides to the thriving central business district and towering skyscrapers of the riverfront to stark urban wastelands in Midtown and the West Side to the crime-ridden northeastern corner would effectively reap the same reward.
The Detroit region itself offers many clear advantages to businesses. Close proximity to a leading university, a skilled workforce, rapidly increasing availability of venture capital funding and international transport links are only a few such assets. As such, it is not beyond the bounds of economic possibility that businesses would invest in the city or its surrounding environs.
What Freedom Zones are likely to do is to marginally influence the location of specific investments, perhaps attracting offices to the city’s central business district, or plants along its major freeways. Jobs that would have probably been created in the suburbs anyway will be moved slightly within the city limits and are likely to be dominated by suburban commuters. Residents must still contend with crumbling infrastructure, failing schools and a dysfunctional transport system. Paul’s plan does include targeting provisions. Corporations must either produce at least 10% of their income from activity in the Zone or have at least 25% of their employees as residents of a Freedom Zone. It is not immediately clear whether employment figures would be calculated at the unit, plant or company level for corporations operating at multiple sites. It would also exclude companies with gross incomes in excess of $500 million from participating. These provisions ensure that the tax cuts are not entirely indiscriminate with regard to which companies can claim them and who they hire. They are indiscriminate with regard to where businesses locate within the city, however, which is likely to concentrate investment in its most developed sections. There are also no comparable requirements for individuals or for companies filing as individuals, only that their permanent residence be situated within the boundaries of the Zone.
Further issues emerge with the prescriptions for education within the Zones. Paul seeks to increase competition and student choice within the Zone’s school system through two primary levers:
1. Making Title 1 Federal education funds portable, so that they would follow the students, allowing their families to choose which school they attend.
2. The creation of a $5,000 tax credit* for each child to pay for schooling of their caregiver/s’ choice.
Detroit has no shortage of competition in the form of charter schools. Their quality is variable and as the public schools they compete with are so poor, with graduation rates below state and national averages, this competition has not encouraged a substantive race to the top. Furthermore, with the closure of many of the city’s parochial schools, it is unclear how much of a private education $5,000 would buy*
Detroit’s problems are decades in the making. The causes of its decline are manyfold and often defy conventional political categorisation. If “liberal policies have failed our inner cities”, conservatives have an opportunity but a responsibility to identify and pursue policies which will succeed. Economic Freedom Zones are a good start, but they should more closely follow the laws of economics.
*Though named as a credit it is described as a tax deduction. A deduction would be non-refundable, meaning it could only reduce an individual’s existing tax rate. Those on low-incomes whose tax rates are less likely to qualify
*Private schools do, of course, offer financial aid.