Is there a tradeoff between economic development incentives and economic freedom? Evidence from the US states

Abstract

State and local governments have used targeted incentives to recruit businesses for decades. The relationship between incentives and business formation, employment, and economic growth has been studied in detail. This paper extends this literature by examining the relationship between development incentives and economic freedom – where economic freedom refers to the ability of individuals and firms to enter into contracts and use their property as they see fit without permission from government (Gwartney, Lawson, and Hall, 2016). Optimal tax theory assumes an exogenous government revenue constraint, suggesting that taxes not collected from some businesses result in higher taxes on others, which may negatively impact economic freedom. By contrast, tax breaks could diffuse across firms and thus positively affect economic freedom. The paper investigates this relationship with state-level panel data between 1994 and 2013.We find an economically and statistically significant negative relationship between incentives and freedom, which are robust to several specifications.