The History and Application of the Arizona Constitution's Ban on Corporate Welfare
The Arizona Constitution’s “Gift Clause” — which says that “Neither the state, nor any county, city, town, municipality, or other subdivision of the state shall ever give or loan its credit in the aid of, or make any donation or grant, by subsidy or otherwise, to any individual, association, or corporation…” — represents the strongest prohibition on government aid to private enterprise ever written.
Arizona’s Constitution was drafted in 1910, after a century of ill-conceived, often catastrophic, government investments in private businesses. In the wake of the Erie Canal’s completion in 1825, many state governments hoped to imitate its success by funding “internal improvements” projects such as canals and railroads. But few of these even managed to pay off their costs of construction. In fact, many were never even completed. By the 1830s, over-investment in “improvement” projects for which there was insufficient market demand led to massive economic declines and even the bankruptcies of several states.
In response, citizens demanded new constitutional prohibitions against future state funding of private undertakings. The first of these was adopted in Rhode Island’s 1843 Constitution, which declared: “The credit of the state shall not be directly or indirectly loaned in any case.” Even stronger was the version adopted in Illinois — which had barely escaped bankruptcy after a disastrous railroad investment scheme. Not only did it promise that “the credit of the state shall not, in any manner, be given to or in aid of any individual, association or corporation,” but it empowered the legislature to “encourage internal improvements” only “by passing liberal general laws of incorporation” — that is, by leaving it to the private market.
But while most states adopted similar Gift Clauses in the years that followed, they eventually proved inadequate because these provisions still allowed cities to fund private businesses. Thus, in 1871, when the California Supreme Court upheld a law whereby the city of Stockton financed construction of a private railroad—which despite hundreds of thousands of dollars of government funding, ended up never being built—voters demanded reform. In 1879, voters adopted a new Constitution which barred cities as well as the state from subsidizing private businesses.
Then as now, government subsidies to private businesses proved economically wasteful — as government demonstrated its inability to accurately predict future consumer needs — as well as corrupting, as government financial aid to businesses often encouraged lobbying, log-rolling, and back-room deals by crony manipulators who often took public funds and then failed to build the railroads or canals they were supposed to build. When, in 1883, the Arizona Territorial Legislature devoted a quarter of a million dollars of taxpayer money to build a railroad connecting Tucson and Globe, voters were horrified to find that only about twenty miles of track were ever built.
Such outcomes are typical because government officials are not equipped to predict market trends, and are therefore incapable of choosing which businesses “ought” to prosper. In fact, they may be worse-equipped, given that they have less financial incentive than private businesses do to determine what consumers actually want. Moreover, government officials are subject to pressures from lobbyists who seek financial benefits from the government based on their political influence instead of what buyers and sellers actually desire in the marketplace. This explains why government-subsidized businesses so often fail: the very fact that they rely on political influence to survive, rather than on producing goods and services buyers actually want, means they’re often destined for failure. Indeed, that very fact is why such businesses ask for government aid: because they can’t persuade private financiers to lend.
But subsidies don’t just take the form of outright payments. In fact, when the Arizona Constitutional Convention began in 1910, the state’s founders hoped to put a stop to a more insidious type of subsidy: tax exemptions. Throughout the nineteenth century, many states had used exemptions from taxes to subsidize railroad development without having to spend money from the treasury. Lawmakers in the Land of Lincoln, for example, agreed to exempt the Illinois Central Railroad from taxation to subsidize construction—leading to a U.S. Supreme Court ruling a quarter-century later making the exemption a contract, which made it irrevocable.
Tax-exemption subsidies resulted in unfairness, because other taxpayers had to shoulder more than their fair share of the tax burden. They also led to the same corrupting consequences that outright spending caused. That became clear in Montana Territory in the 1880s, when factions split the state over tax-exemption subsidies to two competing railroads. Montanans eventually decided to ban tax-exemption subsidies in their 1889 Constitution — and it was that language that Arizona’s constitution makers copied word-for-word into their own work in 1910. The Montana/Arizona Gift Clause banned not only gifts and loans, but also financial aid “by subsidy or otherwise” — a broad catch-all phrase intended to block any form of public financial assistance to private enterprise, including exemption from taxation.
Since then, judges in the Grand Canyon State have been remarkably conscientious about enforcing the constitutional ban on government subsidies — whether direct or indirect. For example, in 2010, the state Supreme Court held that Phoenix officials violated the Gift Clause by arranging a scheme to “buy” parking lots from a shopping mall developer for $97 million — which came out to more than $450,000 per parking space — because such an excessive amount meant the agreement was really just a disguised “gift” of taxpayer funds to the developer. A decade later, it struck down a plan by the city of Peoria to pay a private university $1.8 million simply to operate in the city — an arrangement the court likened to paying a McDonald’s to sell hamburgers.
Most importantly, the court made clear that the government cannot subsidize private companies just out of a hope that these companies will eventually contribute to a better economic environment. “A private business will usually, if not always, generate some economic impact,” the justices declared. “Consequently, permitting such impacts to justify public funding of private ventures would eviscerate the Gift Clause.”
Arizona courts have also prohibited various disguised forms of subsidy, including laws that eliminate someone’s debts, or that lease or sell government-owned property at below-market rates. In a 2022 case which I litigated in my role as an attorney with the Goldwater Institute, judges struck down an effort by Pima County to devote $15 million in taxpayer money to construct an office building and manufacturing facility for a company that intends to take passengers on rides to the upper atmosphere in specially modified weather balloons.
But there’s one issue Arizona courts will soon have to contend with: an increasingly common form of subsidy called a “GPLET scheme.” GPLET stands for Government Property Lease Excise Tax, and it was originally intended to apply in situations where private businesses operate on land leased from the government. Since government-owned land is exempt from property tax, such businesses would ordinarily escape taxation, so the GPLET statute was passed to impose a modest tax on these companies. In recent years, however, local governments have exploited the statute to exempt companies from taxes—as a means of subsidizing them.
It works like this: a city agrees to “buy” property from a business for $1 or another token amount, whereupon the property becomes “government-owned,” and exempt from the property tax. Instead, it’s subject to the GPLET tax — but then the city can then waive that — whereupon the property becomes entirely tax-free. After several years of tax-exemption — during which the business operates as if it owned the land still — the government returns the property. The result is a boost in the business’s bottom line, because the taxes have been nullified.
In June 2020, an Arizona judge ruled that Phoenix violated the Gift Clause by using a GPLET scheme to subsidize construction of a high-rise apartment building through a tax-exemption worth more than $20 million. “The benefits received by [the developer] are grossly disproportionate to the benefits received by the City,” the judge declared. But so far, no court of appeals has addressed the constitutionality of GPLET schemes. Given that one of the main reasons the Gift Clause was written was to block tax-exemption subsidies of the type used in western territories in the nineteenth century, the best legal conclusion is that subsidies like these are unconstitutional.
Arizona’s Gift Clause is the strongest restriction on “corporate welfare” ever adopted in America. Courts have so far done a remarkably good job of enforcing it — and should be vigilant about maintaining that record in the future.
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Timothy Sandefur holds the Barry Goldwater Chair in American Institutions at ASU and is a professor of practice in the Center for the Study of Economic Liberty. His articles “The Origins of the Arizona Gift Clause” and “The Arizona Gift Clause in the Twenty-First Century” were just published by the Regent University Law Review and the Drexel Law Review, respectively.
