Political Connections and Government Subsidies: State-Level Evidence

Abstract

We examine whether economic incentive awards by U.S. state governments to corporations are affected by political connections, and importantly whether a relation is cause for constituent concern. Consistent with findings examining international and U.S. federal-level political connections, we find that U.S. state governments also allocate resources disproportionally to politically connected firms. A firm is nearly four times more likely to receive an award, and the award is 63 percent larger, when the firm makes campaign contributions to state politicians. To determine if this relation distorts or enhances government resource allocation effectiveness, we focus on three key stakeholders: politicians, taxpayers, and shareholders. The positive relation between incentive awards and political connections is stronger when politicians’ motives appear self-serving. Although the stock market reacts more positively to connected award announcements, these awards generate less local job growth and less aggregate local economic growth, suggesting a wealth transfer from taxpayers to connected firm shareholders. Consistent with this interpretation, connected firms commit to fewer jobs and less capital investment per dollar of incentive awarded. In sum, state governments disproportionately award incentives to politically connected firms, even though these awards are a less effective allocation of government resources. Our study thus identifies a channel through which politicians can transfer rents to connected corporations at the expense of local taxpayers.