It originated, not in a fear of railroads, but of politicians and crony capitalism
By Karen Gray
LAS VEGAS — It’s long been agreed in Nevada that the state constitution’s prohibition against state subsidies to private business means just what it says:
The State shall not donate or loan money, or its credit, subscribe to or be, interested in the Stock of any company, association, or corporation, except corporations formed for educational or charitable purposes.
Moreover, Nevada voters have made their own view emphatically clear: Three times — in 1992, 1996 and 2000 — they’ve rejected lawmaker-sponsored ballot measures to change the state constitution and allow such subsidies.
But have Silver State lawmakers and the Sandoval administration now found a successful end-run around the clearly expressed will of the voters?
In 2011, the legislature passed, and Gov. Brian Sandoval signed, Assembly Bill 449, an act explicitly establishing a “Catalyst Fund,” from which the state Office of Economic Development — a department created within the Office of the Governor, with its board chaired by the governor — may make “grants or loans of money” to “regional development authorities.” In turn, the regional development authorities must use the money for “grants or loans to, or investments in, businesses seeking to create or expand in this State or relocate to this State.”
Being able to direct taxpayer dollars to private businesses has long been the desire in Carson City, as the three measures placed on the ballot and the 2011 Catalyst Fund law show. And lawmakers have not been shy about placing a heavy thumb on the ballot-measure scale.
In 1992, the pro and con arguments for that year’s ballot question were written — as always when the measure is proposed by assembly or senate joint resolutions — by the legislature’s own employees, the Legislative Counsel Bureau.
The LCB devoted 106 words to the argument for the measure, and less than half that, 47 words, to the argument against the measure.
The pro argument depicted the constitutional ban as merely an antiquated 19th Century move “to prevent powerful railroad companies from using their political influence to obtain loans and grants from the state,” and said the ban “limited efforts to bring economic development and economic benefits to Nevadans by restricting the state’s ability to make loans to private companies.”
The “con” argument was even written to assist proponents — stating that “the railroads no longer have excessive political influence over state government” — before going on to acknowledge that the existing provision had “not prevented the state from supporting economic growth or making prudent investments,” and that it could “still be useful in preventing the state from becoming financially involved in private companies.”
Even with the legislature’s thumb on the scale, the ballot measure went down to overwhelming defeat with Nevada voters resoundingly sided with the opponents. Only 23.5 percent of the electorate — 109,739 voters — favored changing the constitution, while 76.5 percent — 357,190 voters — rejected the idea.
Remarkably, despite voters’ overwhelming rejection of the proposal, Carson City lawmakers, the governor, the state department of commerce and recognizable business people not only remained insistent on changing the state constitution, but continued crafting a detailed strategy for doing so.
So, in 1993, proponents went back to the drawing board. They set about “cleaning up the language” to convey the “correct message” to voters, in the words of then-state treasurer Bob Seale.
Larry Struve, the then director of the state Department of Commerce, told Assembly Ways & Means that his department had successfully raised $66,000 in private matching funds to add to the $50,000 in tax dollars that lawmakers had conditionally appropriated in 1991 when then lieutenant governor Sue Wagner created “Focus 2000,” a new plan for economic diversification and development. The plan had allocated state money — if matched by private funding — “for the development of a plan for a program which used public and private money as capital for investment in new enterprises.” That $116,000 total then allowed a “Development Capital Fund Steering Committee” — made up of the private donors to the fund — to hire Belden Daniels, an economic development professor at Harvard for 10 years, as a consultant.
The steering committee selected Daniels’ because of the great success his firm reported in leading campaigns to remove “anti-donation clauses” — that is, prohibitions of state gifts to businesses — from four state constitutions: Kansas (1986), Wyoming (1987), Georgia (1988), and Oklahoma (1988).
“No targeted amendment that we have designed has been defeated,” boasted Daniels’s “market analysis & business plan.”
His firm, Economic Innovation International, had been retained by the steering committee as of October 1992, only shortly before Nevada voters rejected that fall’s proposal to remove the no-gifts-to-private-businesses clause from the state constitution.
Nevertheless, Daniels was directed to develop a business plan for a capital investment program that would join public tax moneys to private dollars and put the resulting funds into private businesses.
The program, Daniels told lawmakers in April of 1993 according to legislative minutes, would mean a $20-$30 million investment fund that “would bridge the gap between banks and owners of small manufacturing firms.”
His “principle focus,” he said, was the “risk capital, that capital necessary for a profitable, growing firm which cannot reasonably be borrowed from a bank.”
The state’s “Nevada Development Capital Fund would be a partner with Nevada banks by investing risk capital and lending long-term debt to growing customers,” Daniels said.
“The fund would also aid certified development companies, venture capitalists, development authorities and investors,” he indicated, according to the minutes.
Elements specifically suggested by Daniels were subsequently incorporated by Nevada lawmakers in their joint resolutions seeking voter approval for weakening the constitution’s no-gift clause.
In 1996 and then again in 2000 when employees of the legislature drafted the pro and con arguments on the measures, the lawmakers’ heavy thumb again showed up on the ballot scale.
The for argument in 1996 got 57 words, while the vague against argument only counted 32. And in 2000, the for argument got 169 words, while the unfocused against argument only counted 87.
But it was all to no avail. Voters had not changed their minds — even when the scheme was couched in Daniels-approved language.
In 1996, with 64.8 opposed, and then again in 2000, by a 59.3 percent in opposition, Nevada voters resoundingly rejected the orchestrated attempts to amend the Silver State’s constitutional prohibition against state gifts and loans to private corporations.
Correcting the record
When legislative staffers were writing the 1992 ballot-question arguments depicting Nevada’s anti-gift clause as a 19th Century leftover, they suggested that the reason behind the provision had been “to prevent powerful railroad companies from using their political influence to obtain loans and grants from the state.”
In 2000, too, the state legislature’s employees sought to characterize the ban as archaic — “based on conditions existing in the 1800s” — which, in today’s world of “emerging competition in other states,” they asserted, needlessly constricted opportunities for Nevada by preventing “the Legislature from considering laws to permit managed investments” that “would diversify the State’s economic base and improve the standard of living for residents.”
In actuality, however, the ban on state gifts to corporations — which virtually every state placed in their constitutions as the 19th Century wore on — had been a hard lesson learned from hard times: the economic depression of 1837-1843.
It, of course, hadn’t begun that way. Instead, state politicians all across the country thought they’d discovered a sure-fire route to new jobs, to economic growth and — implicitly — the adoration of the public for them, personally. All they had to do, they believed, was route public moneys to job-creating “internal improvements.”
What had occurred was a unique, lucky turn of events in New York state, which, following the War of 1812, had commissioned construction of a canal to connect the Hudson River with the Great Lakes.
The Erie Canal, completed in 1825, says Jeffrey Rogers Hummel, economics professor at San Jose State University, turned out to be “one of those rare and curious instances where a socialist enterprise actually made a good profit.”
Other states rushed to imitate New York, he writes in an Econ Journal Watch article, and an “orgy of canal building resulted.”
Thomas DiLorenzo, an economics professor at Loyola University Maryland, points out that, previously, before the rush to imitate New York, hundreds of privately-financed road-, canal-, turnpike- and railroad-building companies had thrived without government subsidies.
But now, it usually was state government that was building, owning and operating the new canals. Even in “those few instances where the canals were privately owned, the states contributed the largest share of the financing,” notes Hummel.
It was a classic debt-based boom, which first crested in May of 1837. Then, he writes, “a major financial panic engulfed the country’s 800 banks, forcing all but six to cease redeeming their banknotes and deposits for gold or silver coins.”
A sharp depression, which followed the panic, was quickly over, notes Hummel. “Amazingly,” however, “the outstanding indebtedness of states nearly doubled, with a third of that invested in state-chartered banks in the Midwest and South.” Much of that new debt would result in bankrupt states and even harder times.
DiLorenzo explains that enthusiastic state funding of business was the governing doctrine of the Whig Party, which, by 1837, “had achieved a great deal of success in state governments throughout the nation and used [its] political power to commence hundreds of government-subsidized canal and road-building projects.”
It turned out, however, to be a massive waste.
“By 1840, notes Hummel, “the canal boom had blessed the United States with 3,326 miles of mostly economically unjustified canals at an expense to the states of $125 million, a large sum in those days. Virtually all the new canals were a waste of resources and did not deliver the hoped-for monetary returns. Instead, the heavy state investments, when added to budget growth stimulated by the War of 1812, led to massive borrowing.”
Moreover, adds DiLorenzo, in “virtually every single instance where governments intervened to build roads, canals, and railroads during this period the result was corruption and financial debacle.”
While state “subsidies to canals were made with great fanfare and promise,” he writes, the projects were “almost uniformly disastrous.”
Then, hard on the heels of the canal and road-building mania, arrived the railroad enthusiasm.
“By 1840,” writes DiLorenzo, “the railroad had eclipsed canals as the center of the internal improvements.”
Americans were in love with railroads “because railroads defined the age,” writes Richard White, historian and Stanford University economist. However, “the claims made for railroads by men who wrote about them were always extravagant,” he says.
In fact, as White details, the era of railroads was also a time of extensive corruption, political favors, bankruptcy and failure.
In a 2012 interview with the Christian Science Monitor, he termed them “containers for speculation, collecting subsidies and selling bonds, and financial manipulation.” Although they regularly went bankrupt, the men running them still got tremendously rich, notes White.
University of Maryland economist John J. Wallis — in addition a research associate at the National Bureau of Economic Research — has studied the collapse of the internal-improvements programs in the states that made up America’s northwest in the 1830s and 1840s.
He traces the bankruptcies of Indiana, Illinois and Michigan to the collapse and default of an over-extended New Jersey bank, the Morris Canal and Banking Company, which had used the bonds of state-financed internal-improvements projects to become, in his words, “a high-flying investment bank, staying one step ahead of its creditors only by issuing more of its own debt….”
Eventually, the state of Ohio avoided bankruptcy only by descending into illegality, writes Wallis:
Ohio embarked on an ambitious expansion of its canal network in 1836. Since 1839, Ohio had pressured its banks to purchase bonds as it became more expensive to market bonds in New York and in Europe. By 1841, the finances of Ohio were in serious straights and, in January of 1842, Ohio faced prospects of an immediate default. The state authorized the Canal fund to act illegally and the fund “issued to the Ohio Life & Trust $300,000 in state bonds as security on a $200,000 loan, to be repaid within ninety days…. [O]nly by risking their own fortunes and by enlisting the aid of the Trust Company in an illegal operation did the board save the state’s credit.”
“In Ohio, as in other states, revulsion followed the early enthusiasm” for the state subsidies for businesses, wrote historian Carter Goodrich in a book-length study of government promotion of canals and railroads. So much waste and corruption marked Ohio that it soon “stood as one of the chief examples of the revulsion of feeling against governmental promotion of internal improvement,” with the state, in 1851, amending its constitution to prohibit both state and local government subsidies to private companies.
The revulsion extended all across the country — and even to Europe. In Dickens’ A Christmas Carol, Ebenezer Scrooge at one point refers to worthless commercial paper as “a mere United States’ security.” And William Wordsworth, in 1845, published a sonnet, “To the Pennsylvanians,” lamenting the “dishonour” of the state in defaulting on its obligations in 1841.
“After 1842,” writes Wallis, “Americans remembered how their adventures in state finance quickly came back to haunt them:
Americans in Indiana and Ohio were saddled with property tax rates eight times higher than in 1836. New York, Pennsylvania, Maryland, and Massachusetts all had state property taxes, where they had none in 1830. Americans in five states, Florida, Mississippi, Louisiana, Arkansas, and Michigan faced the dishonorable fact that they had repudiated all or part of their state’s sovereign debt. Illinois and Indiana struggled just to get current on back interest payments until the late 1840s. …They remembered an economic recession that got out of control because of the excesses of state economic policy.
We should remember it too.
By 1861, reports DiLorenzo, state subsidies for internal improvements were forbidden by new constitutional amendments in 10 states — Maine, New York, Pennsylvania, Maryland, Minnesota, Iowa, Kentucky, Kansas, California, and Oregon. Wisconsin had constitutionally barred grants and loans to private companies since 1848. Louisiana — which had begun subsidizing railroads as early as 1833 — had been one of the first states to turn around and forbid state aid for internal improvements, in 1845.
And as the 1860s proceeded, even the new states entering the Union — such as Nevada, in 1864 — entered with similar constitutional prohibitions.
A clause forbidding state gifts to corporations had become part of the necessary template for state constitutions.
A forgotten lesson
“Those who cannot learn from history are doomed to repeat it,” wrote George Santayana. And the corruption that characterized the era of state involvement in canals and turnpikes returned with a vengeance when the party of former Whigs, now rechristened as “Republicans,” captured the White House in 1860.
The ensuing era of transcontinental railroads, White told the Monitor, marked the start of modern American corruption, in which “corporations infiltrate the political system and make politics an instrument of corporate policy.”
The public should be, “very leery of giving public money to large corporations on the promise that everything will be fine…” he said. “Often the private sector pretty much protects itself and is confident that the public will come in and bail them out if things go wrong.”
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