First, I would like to commend the task force for undertaking this effort. You have sat through two long days of hearings and heard a wide variety of viewpoints. There is no question in my mind that the quality of public policy decision making would be vastly improved were more legislative bodies to conduct these types of informational hearings, distanced from the wrangling that inevitably accompanies debate over specific legislation.

The subject of this hearing is interstate competition. But, of course, the only reason we care about interstate competition is that we care about the economic well-being of the state. I take your time to state the obvious here because the wrong kinds of efforts to win in interstate competition can actually hurt a state's overall economic health.

Winning interstate competition is easy if it's made a top priority. If Pennsylvania offered businesses moving into the state, reimbursement of all initial capital investment costs, reimbursement of half of the business's payroll costs in perpetuity and a million dollar bounty to each of the corporate officers, the state would no doubt attract a substantial number of corporate immigrants. Of course, the state would also have a very difficult time paying for these incentives at the same time as providing other government services. The price of victory in interstate competition might be poorly maintained roads and parks, inferior schools, cuts in police protection and ineffective social programs.

And, the state's economy might well be worse off. No executive or corporation wants to be in a state with second-rate government services. High crime, poor infrastructure and an unskilled workforce are potentially significant barriers to economic development. Businesses already in Pennsylvania would lose government services they rely on and face new, subsidized, competition.

Fortunately, no one is proposing the outlandish subsidies I have described. But the fact is that when government funds are used, either in the form of tax relief or spending to subsidize business, there is a cost-either in reduced government services or in higher taxes for others. Because, however, the benefits of business incentives tend to be concentrated while the costs dispersed, this tradeoff is sometimes hard to see. After all, if one teacher is laid-off in every elementary school in the state, the impact on education will not be immediately apparent. Over time, among the hundreds of thousands of children sitting in larger classes, there will undoubtedly be some for whom a little less personal attention will make a critical difference. But that impact will be impossible to isolate from all the other influences in their lives.

On the other hand, the 100 employees now working for a hypothetical company moving to Philadelphia from Trenton will be welcomed with a ribbon-cutting ceremony. It may be that, overall, the incentive that brought the business to the state does more harm than good, but that won't be the public face of it.

Not only are the costs of incentives often overlooked, but their positive impact is also frequently overstated. One never knows for sure, of course, whether there has been any economic benefit. Would the company have moved from Trenton to Philadelphia without the incentive? We'll never know for sure. One thing is clear, however. Some companies will receive the incentive for simply doing something they would have done anyway. In other words, a significant portion of business incentives are wasted.

Thus far, I have used the term "incentive" very generally. There are a continuum of incentives ranging from extremely targeted to very broad. The most targeted type of incentive is a provision that only benefits one company. An example of a very broad incentive is cutting the corporate income tax rate.

Broad incentives have the virtue of causing less economic distortion. If a state lowers its corporate income tax rate, all profitable companies benefit no matter what their industry, how many employees they have, whether they're new to the state, etc.. Thus, the market, instead of the tax law, is more likely to decide where capital is invested and which companies thrive. This makes for a better functioning economy overall.

On the other hand, broad incentives are a very inefficient use of government resources for the promotion of economic development. Most of the revenue loss from lowering the corporate income tax, for example, would go to companies that are already located in Pennsylvania, have no intention of leaving and would have made the same investments in the state with or without the tax cut. Only a small amount will go to inspiring companies to increase or start investing in the state. Thus, for the many dollars of reduction in government services, and the attendant negative economic and social impacts, only a very few dollars go to changing corporate conduct in a way beneficial to the state.

The narrowest of incentives are more akin to a business deal than government policy-making. A legislated benefit for a particular company can be either good or bad for the state. It depends on the terms of the deal. It is, however, highly unlikely that the state will ever get a great deal. Too many states and localities are bidding for business for there to be any bargains. In fact, some have argued that there is almost always at least one community that is willing to over-bid for the business. If this is true, and the high bid usually wins, most deals will cost the victorious community more in lost government services or higher taxes than it receives in benefits from increased private investment.

In between the very broad incentives and the single company deals, there are incentives that are targeted at specific types of companies engaged in specific conduct. These obviously create distortions in economic behavior in favor of certain conduct or types of companies, and create economic inefficiencies. Also, as is the case with broad incentives, a significant portion of the revenue loss will go to compensating activity that would have happened anyway.

One way to look at these narrow incentives is that there are two possible results. One is that they have no effect on business behavior at all. If that's the case then they are clearly a poor use of public resources. The other possibility is that they do affect business behavior. That, however, could be just as bad. It means that businesses are responding to the incentives of the tax law instead of the market. This is economically inefficient. Under either scenario, therefore, narrow incentives can cause adverse consequences.

The bottom line is that business incentives rarely are as good as they look. There are enormous hidden costs that will often outweigh the limited private investment that such deals attract. Studies on these issues tend to support this conclusion.

I have attached to my testimony a study by Dr. Robert G. Lynch, an economics professor at the State University of New York. This study surveys the recent economics literature on the effectiveness of tax incentives. Professor Lynch found the studies done on this subject are nearly unanimous in concluding that state and local tax incentives fail to attract business, create jobs, or enhance state economic performance. The major findings of hundreds of survey studies can be summarized as follows:

• There is no evidence that state and local tax cuts, when paid for by reducing public services, stimulate economic activity or create jobs.
• There is little evidence that the level of state and local taxation figures prominently in business location decisions.
• State and local business tax incentives and financial inducements are not the only, or even the primary, influence on business investment decisions.
• Factors such as the cost and quality of labor, the quality of public services (schools, roads and highways, sewer systems, recreational facilities, higher education, health services, etc.), the proximity to markets, and the access to raw materials and supplies are more important than tax incentives in business location decisions.
• There is little evidence that job losses or job transfers from one state to another are a consequence of business tax incentives.

While the benefits of tax cuts and incentives are debatable, their costs are clearer:

• Tax cuts and incentives cause state and local governments collectively to lose billions of dollars annually in tax revenues.
• Because of the lost tax revenues, tax incentives force state and local governments to cut back on the quantity or quality of public services. These reductions can damage the economy because businesses often need these public services to thrive. Indeed, there is evidence that state and local tax cuts, accompanied by reductions in public services, cause job loss and economic decline.
• Business tax incentives provided to some firms put competing firms at a disadvantage. Hence, increases in output and employment by firms receiving incentives may be at least somewhat offset, and perhaps even outweighed, by the decreases in output and employment of competing firms.

Since Professor Lynch wrote this, there have been several studies that have reinforced his conclusions.

Let me note that some of you may have heard of research that has been characterized as reaching different conclusions. Professor Lynch deals with that in his study. While there are certainly studies that show a correlation between lower taxes and faster economic growth, the impact found is very small. In other words, big differences in tax burdens correlate with insubstantial differences in economic growth.

Also, there are studies showing a correlation between more government spending and faster economic growth. Hence, one arrives at the unremarkable conclusion that a state that could somehow manage to spend a lot and tax a little would likely do well economically. That, of course is impossible to accomplish in the real world.

Furthermore, correlation is very different than causation. There are many things that have helped low-tax states. For one thing, many of them are southern states. There are many factors helping these states that have not, in my view, been adequately accounted for in the studies I have examined. These states were, in earlier times, hampered by their distance from shipping routes to Europe, climate and the need for centralization in many industries. As transportation, communication and air conditioning technology has improved, southern states have been freed of these handicaps. It was inevitable that these previously lagging states' rates of economic growth would improve.

Thus, even the extremely limited impact suggested in these studies is suspect. In a nutshell, any possible impact of business incentives and lower taxes are swamped by the myriad of national, regional and local other factors determining a state's economic performance.

None of this means that no incentive has ever worked in a given instance. But it does indicate that incentives and broad tax reductions are not a key to improved economic conditions.

But, if business incentives don't work, what is a state to do? I have a very unexciting answer: get the basics right. The best education system will produce a productive population that will be a tremendous economic asset. Quality-of-life issues, including crime, also matter to businesses because the people who run and work for businesses, and their customers, care about them. A well-maintained, adequate, infrastructure is also important to business and economic development.

In other words, government should do the things government does well and efficiently. After all, most economic development comes from within--from businesses created by the people already living in a state. The people of Pennsylvania are its greatest resource. Ensuring that every citizen has the government services needed to allow them to use their talent to the fullest, is the greatest potential source of economic development the state has. This isn't a silver bullet solution, but the fact is that state and local governments are seldom the cause or barrier of economic growth. So getting the basics right is both the most, and the least, that government should do.

I would like to close with a comment about tax issues in general. Everyone complains about taxes. Business owners do, workers do and retirees do. Everyone has an idea of how much they should reasonably pay in taxes and everyone has an idea of what government services they should get in return. But a taxpayer's "purchase" of government services is very different from any other kind of purchase. In a normal retail transaction the customer gets to choose precisely what they're buying for their money. With government services, the decisions have to be made communally. It is a process that by definition is going to leave most people unhappy-not because government is doing anything wrong-but because the community is not, and never will be, of one mind on the subject.