In 1993, Alabama emerged victorious as the site of Mercedes-Benz AG’s first U.S. car plant. States like Alabama are vying more desperately than ever to lure new industrial jobs and hold on to those that they have. To start with, they give away millions of dollars in free land. After that come fat checks for site clearance, training, even employee salaries. Both foreign and domestic companies are finding ingenious ways to cash in.
Mercedes initially had so little interest in Alabama that Mercedes’ site-selection team did not even plan to visit the state. Of more than 20 states that Mercedes looked at seriously, it initially leaned toward North Carolina, where Mercedes parent, Daimler-Benz AG, already builds Freightliner trucks. North Carolina officials say that their governor pursued Mercedes harder than he ever had pursued any potential investor. Mercedes officials were reportedly surprised at the enthusiastic response to their request for tax and other subsidies, but they were quick to cash in. Mercedes would get offers for certain things from certain states, put it on their ideal contract proposal, and then come back to the other states and ask if they would be willing to do the same. For example, Mercedes persuaded all the main competitors to offer $5 million for a welcome center next to the factory, where customers could pick up cars, have them serviced, and visit an auto museum. It got commitments for free 18month employee-training programs. It also got state governments and utilities to promise to buy large quantities of the four-wheel-drive recreational vehicles that the new factory would produce. Mercedes officials even asked the states to pick up the salaries of its 1,500 workers for their first year or so on the job, at a cost of $45 million. The workers would be in a training program and would not be producing anything, Mercedes explained. Although North Carolina and other state officials said no, Alabama said yes, even to the salary request. Alabama economic development officials argued that the Mercedes project simply was worth more to Alabama than it was to any other state.
When Mercedes found North Carolina proposing to build a $35 million training center at the company’s plant, the German automaker enticed Alabama to more than match the North Carolina offer. To outbid the competition, the Alabama governor hurriedly won legislative approval for lavish tax concessions  dubbed Alabama’s Mercedes Law  and offered to spend tens of millions of dollars buying more than 2,500 Mercedes vehicles for state use. In the bargain, Mercedes says it agreed to limit itself to using just $42.6 million per year in income and payroll tax credits; Alabama officials say that was all Mercedes expected to be able to use, based on profit projections. It also will be allowed, however, to escape more than $9 million a year in property taxes and other fees, as permitted under existing law. Although South Carolina offered $80 million in tax credits over a period of 20 years, Alabama granted Mercedes a more attractive tax credit, available in advance in the form of an interest-free loan. Mercedes officials also say Alabama’s promised education spending was double any other state’s promise. Alabama officials even agreed to place Mercedes’ distinctive emblem atop a local scoreboard in time for the big, televised Alabama-Tennessee football game. The price? Why, free, of course. In all, Alabama wound up promising Mercedes over $300 million in incentives, which economic development experts called a record package for a foreign company.
How has it worked out in the long run? Very well, say supporters of the Alabama program. In 2000, Mercedesannounced it would invest another $600 million in a major expansion at its Tuscaloosa, Alabama, site to double production for the next generation Mercedes-Benz M-class sport utility vehicle. The expansion doubled production capacity from 80,000 units to roughly 160,000 units at the Tuscaloosa facility and generated up to 2,000 new jobs. In announcing the expansion, company officials stressed that their success would not have been possible without the partnership they had formed with the state of Alabama and the strong workforce that they found there. With the new expansion, Mercedes is on target to become the fifth largest employer in Alabama, with more than 7,000 employees between its Chrysler electronics plant in Huntsville, Alabama, and the Tuscaloosa Mercedes-Benz factory. The total capital investment made by the company in Alabama is expect to rise to more than $2.5 billion, once the expansion is complete.
Critics complain that Alabama subsidies used to land the Mercedes-Benz deal represent an egregious example of “corporate welfare.” During recent years, as many as 44 of the 50 states have stepped up to offer economic incentives for corporations to relocate, rebuild, or remain in their jurisdictions. Detractors argue that handouts given corporations by local, state, and federal governments in the form of subsidies, grants, low-interest loans, or free government service amounts to $150 billion per year. Tax breaks and tax credits add to the bill. In the late1990s, when funding was cut for the federal Aid to Families with Dependent Children program, the action was justified as a means for breaking a "cycle of dependency" among the poor. Critics of government incentives for economic expansion argue that the same indictment applies to corporate welfare. Moreover, instead of helping the poor, corporate welfare rewards the rich and powerful.
A. With $300 million in state aid to attract 1,500 new jobs, the initial marginal social cost to Alabama taxpayers of attracting the Mercedes plant was $200,000 per job. Estimate the minimum marginal social benefit required to make this a reasonable expenditure from the perspective of Alabama taxpayers. Do the facts of this case lead you to believe that it is more likely that Alabama underbid or overbid for this project? Explain.
B. Does the fact that the bidding process for the Mercedes plant took place at the state and local levels of government have any implications for the amount of inducements offered? Would these numbers change dramatically if only the federal government could offer tax breaks for industrial development?
C. Explain how a benefit-cost analysis of the Alabama Mercedes project could account for any potential erosion of the local tax base at the state and local level.
Critics contend that taxpayers in Alabama were denied the opportunities provided by alternate privately-directed capital investment projects because the state chose to redirect public and private investment toward the Mercedes plant project. Instead of enjoying an efficient increase in business activity among a number of smaller enterprises, employees, taxpayers, and consumers are left with a large and potentially inefficient state-directed investment in the auto plant. Do you agree? Why or why not?