Public Funds into Private Pockets: How Corporate Welfare Offends the Constitution

Consider the following hypothetical situations:

One, you are an honest, law-abiding, tax-paying citizen who has never had an interest in professional sports. Your state and local government representatives decide to incur debt and spend millions of dollars to persuade the wealthy owner of a professional sports team to locate in the city where you live. You are informed that the price of a ticket is so high that is unlikely you could afford to go to a game even if you wanted to. A season ticket is out of the question.

Two, you are the owner of a small retail outlet and a believer in the free-enterprise system whereby business people rely on their individual ingenuity to become successful. Your state legislature decides to incur debt and, once more, spend millions of taxpayer dollars to persuade the board of directors of a major corporation to construct a large retail franchise operation in your state – a state with a none-too-good business reputation. The state taxation that has hampered you for years suddenly appears even more cruel, for your new competition is not subject to all of it. The new franchise puts you out of business.

By now, you have realized that these are not really hypothetical examples at all. These are situations that are in fact occurring repeatedly throughout the country – and throughout Maryland. How can such public expenditures be justified? If you ask a legislator or petition the court for an explanation, the answer will be the same: The expenditures are legal because they are expended for a “public purpose.”

But this response is simply wrong. The “lending-of-credit” clause and the “public-purpose doctrine,” provisions within most state constitutions, were not created to provide legislators with an excuse to spend taxpayer dollars on whatever project they chose. Quite the reverse, they were devised to limit such activity. In the case of Maryland, the state constitution contains clear and unambiguous language that explicitly prohibits the legislature from giving any aid to private individuals or corporations, which of course includes professional sports teams and powerful corporate franchisers. Article III, section 34 of the Maryland constitution states, “The credit of the State shall not in any manner be given, or loaned to, or in aid of any individual association or corporation….” This type of provision, the lending-of-credit clause, is contained in at least 45 of the 50 state constitutions. Such provisions also apply to counties, cities and other political subdivisions. Some states also prohibit direct grants to private enterprise.

One might surmise, in light of such explicit wording, that both the Maryland General Assembly and the courts would consider most corporate subsidies to be unconstitutional. Yet, this is not so. Bowing to economic and political pressures, the legislature and the courts in Maryland, in a blatant display of chutzpa, have recently ignored the constitutional prohibition and thus cleared the way for generous corporate access to the public treasury.

Limits on the Legislature
Lending-of-credit provisions and the public-purpose doctrine were intended to limit the power of the legislature to spend tax dollars. This is a very important point. The governing body does not have unfettered discretion to spend public monies. An examination of the history of the Maryland constitutional provision and of early court decisions amply supports this assertion. The lending-of-credit provision was inserted into the state constitution in 1851 as a result of the large debt the state had incurred in an effort to support construction by private railroad and canal companies. This was still understood 126 years later when, in the case of Secretary of Transportation v. Mancuso (1976), the court explained, “The debates of the Constitution[al] Convention of 1850 abound with references to the difficulty of marketing State bonds due to the State’s poor credit condition at that time. This situation resulted from the State’s extension of long-term credit to railroad and canal companies from 1820 to 1840, generally by means of the State’s subscription to the securities of the companies. By 1841, the State’s financial security was threatened by the failure of the foregoing investments (or general revenues) to produce funds sufficient to pay the State’s debt service requirements…. It is thus clear that one of the purposes of the constitutional debt provision was to guard against future credit abuses by including within its purview any evidence of State indebtedness which is secured by its taxing power.”1

Early Maryland cases accorded due respect to the plain meaning of the constitution. For example, Baltimore & D.P.R. Co. v. Pumphrey (1891),2 revolved around Anne Arundel County’s proposal to sell bonds to purchase stock in a railroad company. The court determined that the scheme was unconstitutional and stated, “The language of this section of the constitution is very broad and comprehensive and with a common knowledge possessed by the whole people of the state we cannot fail to understand what was intended to be accomplished by this constitutional provision. It was intended as a constitutional limitation of power, not only of the local authority, but of legislative power itself; and all such cases as the present were manifestly contemplated as being within the evil intended to be restrained [emphasis added].”3

As late as the 1960s, instances of judicial restraint still occurred. Maryland Industrial Development Financial Authority v. Helfrich (1968) involved an attempt by the state industrial-development authority (MIDFA) to guarantee the payment of mortgage loans issued to private industrial companies.4 The Maryland court refused to approve the guarantees and stated, “[W]e will not construe the faith and credit clause of the Constitution to mean less than what it says, and it is our view that [MIDFA's] attempt to pledge the State’s faith and credit to the guaranty of mortgages [of private corporations] … is unconstitutional and void.”5

One would think that in light of such strong judicial language, Maryland courts would be reluctant to approve aid to private corporations on the level that exists today. But such is not the case. The courts in Maryland have exhibited a disturbing propensity to bow to what they perceive as economic imperatives and to ignore the explicit meaning of the constitutional provision.

Despite the court’s 1968 ruling in Helfrich, the slippage had already started earlier in the 20th century. A case often supd in support of corporate welfare is Johns Hopkins University v. Williams (1952),6 a clear example of the judicial schizophrenia exhibited by the courts on the subject of public subsidies since this case was decided before the Helfrich case. Johns Hopkins involved a taxpayer’s suit to enjoin the Board of Public Works from issuing a state loan of $1.5 million and giving the proceeds to the Johns Hopkins University for the construction of an engineering building. Although the court acknowledged the evils that had given rise to the lending-of-credit clause in the first place, it nevertheless held that the provision did not apply to cash gifts to educational institutions.

Witness the court’s specious reasoning. The court commenced from the dubious proposition that, while the construction of statutes and constitutional provisions was a judicial function, courts might, in declaring their meaning and effect, avail themselves of the construction put upon them by the legislature by long-continued custom and usage.7 The court then supd several instances where the legislature had in the past given state bond proceeds to private universities. In light of this prevalent practice, the court opined, “In view of the many previous bond issues for similar purposes, it is quite late for us to change the long continued legislative and executive construction of Section 34….” In short, the court knew it was wrong, but took the easy route, regardless.

Think for a moment about the practical effect of this judicial legerdemain: The Maryland legislature in 1850, after considered debate concerning the ruinous increase in debt caused by the imprudent activities of previous legislatures, decides to insert a particular provision into the constitution limiting the power of future legislatures to incur debt. Subsequent legislatures simply ignore the provision. The court, duty-bound to uphold the constitution, in 1952 then sanctions the actions of future legislatures based on previous legislative practices that had flagrantly violated the explicit provisions of the highest law in the state!

In an amazing display of judicial sleight of hand, the John Hopkins court also stated that a gift of cash was not prohibited by the lending-of-credit provision, even though the state had borrowed the money to give to the university. The court stated: “Cash is not credit. Credit is sometimes a means of procuring cash, but the word is never used to describe a gift of cash…. If the State does not have this amount ($1,500,000) available, but borrows it and then gives the cash to the University, … it is not giving or loaning its credit to, or in aid of, the University – it is using its credit with banking institutions to borrow the money, and it is giving the University its cash.”8

It light of such dubious decisions by the courts in Maryland, it is no wonder that governing bodies feel that they have unlimited discretion with respect to the manner in which they spend public funds.

Public-Purpose Doctrine
There is a judicially created rule which was originally designed to impose an additional limit on the power of the governing body spend tax dollars. A corollary of the lending-of-credit provision, this rule, which has been read into the Maryland constitution, is referred to as the public-purpose doctrine. The basic premise of the doctrine is simple: Public monies may only be spent for “public purposes.” The public-purpose doctrine was created to achieve the same goal as lending-of-credit provisions, namely, to prevent public money from flowing into private hands. The rule was designed to prohibit government from giving public money to private corporations to satisfy “public” desires. However, what is or is not a “public purpose” is subject to a wide degree of modern judicial interpretation. On the other hand, constitutional lending-of-credit provisions are crystal clear: The public entity is prohibited from using public money to aid private corporations, irrespective of whether there is a public purpose involved. Taken together, the two measures should ensure the retention of taxpayer funds for public goods. However, while the lending-of-credit clause has basically been ignored, the public-purpose doctrine – which started out as a straightforward rule that was created to place a limit on the power of the public entity to spend tax dollars – has been so distorted by the courts as to render it totally ineffective.

The public-purpose doctrine was initially pronounced in 1853 in the case of Sharpless v. Mayor of Philadelphia.9 This case involved a taxpayer lawsuit against the City of Philadelphia to prohibit the city from issuing bonds, the proceeds of which were to be used to purchase railroad stock. The taxpayer was concerned that the incurring of debt by the city for the purpose of investing in private enterprise was not a public purpose. The court allowed the money to be used to purchase the stock, but only because the court deemed the railroad to be performing a public function, namely, an internal improvement which the governing bodies traditionally performed. The court was emphatic, however, that public aid to private corporations not performing traditionally public-sector projects could not be construed as being for a public purpose: “[T]he right of eminent domain cannot be used for private purposes; and therefore if a railroad, canal, or turnpike, when made by a corporation, is a mere private enterprise, like the building of a tavern, store, mill, or blacksmith’s shop [the use of eminent domain is unconstitutional].”10

Two subsequent cases, Bay City v. The State Treasurer,11 decided in 1871 by the eminent Michigan jurist Thomas Cooley, and Loan Association v. Topeka,12 decided in 1874 by the United States Supreme Court, both placed a much more restrictive interpretation on the public-purpose doctrine than the Sharpless court had. In the Bay City case, Justice Cooley, a Michigan Supreme Court justice who wrote the famous treatise titled “Constitutional Limitations,” struck down a scheme involving aid to railroads as not being for a public purpose in that the plan involved the payment of public monies to a private corporation. Justice Cooley’s reason for denying the aid seems prophetic: “[T]hese provisions in our constitution do preclude the state from loaning the public credit to private corporations, and from imposing taxation upon its citizens or any portion thereof in aid of the construction of railroads. So the people supposed when the constitution was adopted. Constitutions do not change with the varying tides of public opinion and desire; and it cannot be permissible to the courts that in order to aid evasions and circumventions, they shall subject these instruments … to a literal and technical construction, as if they were great public enemies standing in the way of progress, and the duty of every good citizen was to get around their provisions whenever convenient. They must construe them as the people did in their adoption [emphasis added]….”13

Likewise, the U.S. Supreme Court’s 1874 ruling in Loan Association v. Topeka removed all doubt: Public monies expended to aid private enterprise could not be deemed to be serving a public purpose; such actions were therefore unconstitutional. The Topeka case involved an effort by the City of Topeka to issue bonds payable to a private corporation to encourage the corporation to locate in the city. The Supreme Court, in deciding that the issuance of the bonds was not for a public purpose, stated, “If it be said that a benefit results to the local public of a town by establishing manufacturers, the same may be said of any other business or pursuit which employs capital or labor…. No line can be drawn in favor of the manufacturer which would not open the coffers of the public treasury to the importunities of two-thirds of the businessmen of the city or town [emphasis added].”14

Obviously, these landmark cases were decidedly against public aid to private corporations. But how have Maryland courts applied the public-purpose doctrine? The answer is, just as with the constitutional lending-of-credit provisions, early Maryland courts had it right; later ones did not. In Baltimore & E.S.R. Co. v. Spring (1895),15 the commissioners of Talbot County proposed to issue bonds to pay the claims that certain residents of the county had against a railroad. The court disallowed the plan, stating that its object was the benefit of private persons. It was not for a public purpose – right decision.

But a subsequent 1928 case, Finan v. Mayor & City Council of Cumberland, approved the use of public funds for the construction of a non-profit hospital. This case opened the floodgates of legislative discretion by stating, “What is a public purpose for which public funds may be expended is not a matter of exact definition; it is almost entirely a matter of general acceptation [sic, i.e., acceptance].”16 Is this the message to be gleaned from the Sharpless, Bay City and Topeka cases, decided in other, perhaps more prudent states? Were not these cases very specific in prohibiting aid to private corporations? Nowhere in these latter cases is it stated that an amorphous public’s general “acceptation” should decide what is and what is not a public purpose. This is and should be a judicial responsibility – other than in Maryland, apparently. If the Maryland judiciary had given proper respect to the considerable and well-thought-out case precedent, the public-purpose doctrine would still have some teeth to it, serving its purpose of imposing a limitation on the power of the governing body to spend tax dollars.

Maryland courts further weaken the public-purpose doctrine in one other important way. For example, the court, in City of Frostburg v. Jenkins (1957), stated that an expenditure is for a public purpose if the public receives a “benefit.”17 The implication of such a rule is that the governing body can justify giving or loaning money to anyone as long as it can point to a public benefit, any public benefit. The usual spiel the public hears from government is that an expenditure for a sports stadium or a tax break for a corporation is for a public purpose because the public receives the benefit of additional jobs. But if all the governing body has to do is point to some “benefit” to satisfy public-purpose dictates, how can the doctrine serve as a limitation on the power of the government to expend tax dollars? This is just what Topeka warned against. Any action can lead to some benefit for persons other than the direct beneficiary. But this does not – or at least should not – mean that the “public” is being served.

More insulting still, the 1984 case, Bowling v. Brown, ruled that there was no prohibition against the payment of public funds to private persons or institutions so long as a “public purpose” was being served.18 This latter case sacrificed the lending-of-credit clause before the alter of an immasculated public-purpose doctrine. Thus, the public-purpose doctrine is now used by the courts as a way to avoid the prohibition clearly set forth in article III, section 34 of the Maryland constitution. This certainly was not the original consideration behind the public-purpose doctrine.

Table 1

Conclusion
Finally, it should of course be noted that the entire responsibility for the outrageous subsidies extended by public entities to private corporations does not rest solely with irresponsible court rulings. A large share of the burden must be borne by equally irresponsible elected legislative and executive officials. Nonetheless, the final responsibility must rest with the courts, for it is they that are the arbiters of constitutionality, not legislators. History provides the context for why limitations must be imposed on governing bodies with respect to the expenditure of public monies. What is currently happening in our country in connection with public subsidies to private corporations cries out for a solution. Yet, we have the tools at our disposal – the state constitution! All we have to do is read it. All we have to do is ensure the courts adhere to it.

Mr. Rubin is a professor of law at Willamette University, Salem, Oregon.

End Notes
[Back] 1. 278 Md. 81; 359 A. 2d 79, 81 (1976).

[Back] 2. 21 A. 559 (1891).

[Back] 3. Id. at 562.

[Back] 4. 243 A. 2d 869 (1968).

[Back] 5. Id. at 877.

[Back] 6. 86 A. 2d 892 (1952).

[Back] 7. Id. at 894, citing Humphreys v. Walls; 169 Md. 292, 299; 181 A. 735, 738.

[Back] 8. Id. at 901.

[Back] 9. 21 Pa. 147 (1853).

[Back] 10. Id. at 170.

[Back] 11. 23 Mich. 499 (1871).

[Back] 12. 87 U.S. (20 Wall) 655 (1874).

[Back] 13. Id. at 505.

[Back] 14. 87 U.S. at 665.

[Back] 15. 31 A. 208 (1895).

[Back] 16. 154 Md. 563; 141 A. 269, 270 (1928).

[Back] 17. 136 A. 852 (1957).

[Back] 18. 469 A. 2d 896 (1984).

Posted in: Corporate Welfare, News Series