Econ Matters: Do we really benefit from tax credits?
Proponents of tax credits make two arguments. Some contend that tax credits are instruments for economic development. Others say that the economic development argument is tenuous but contend that without a tax credit program, Missouri would not be able to compete with other states offering programs. In other words, Missouri would hear a giant sucking sound as businesses would be bid away.
Before I make an economic argument, let me ask one question: Where is the evidence that a state’s economy grows faster with larger tax credit programs? Politicians might tell you they saved your community valuable jobs because they developed the right tax credit program, but there is not a shred of credible evidence that tax credits work in this sense.
I concede that companies are weighing the costs of doing business when they make a location decision. Companies face all sorts of costs: labor, borrowing, materials, taxes and others. And if they can reduce their tax burden and hold everything else constant, they will choose the lowest-cost location. They owe that to their shareholders.
But good economic analysis does not stop there. No magic multiplier effect is created because of the government tax credit. Rather, the evidence points to a substitution from all other industries to the ones receiving the tax credit. Put more directly, here’s a reasonable prediction of the effect that the IBM location in Columbia will have on the city’s total private employment a year from now: It will be about what it is now because people will substitute out of current unemployment or other employment into the jobs at the IBM location. That is what the evidence suggests.
Proponents will assert that those employed by IBM were underemployed — either actually unemployed or employed elsewhere earning lower wages. If this assertion is true, then maybe the broadest measure of the city economy — personal income — will show an uptick attributable to a company receiving a tax credit.
IBM will produce valuable goods. People believe that IBM’s effect will be multiplied throughout the local economy; IBM employees will spend money and create a demand for goods and services.
The evidence, however, suggests that no such spillovers or multipliers arise. For one thing, the city’s tax base has shrunk. To supply the same number of services, revenues must be made up by applying a larger-than-otherwise tax rate to the remaining tax base.
Insert here the old adage, you can’t get something for nothing. Columbians, and more broadly Missourians, are paying the tax bills for those companies receiving tax credits. With 5.5 million Missourians, it comes to only about $4 per head, but you are paying it.
The incremental increase in the state’s and city’s tax rates amount to a redistribution of resources. In other words, you can account for the absence of any positive correlation between tax credits and economic growth by realizing that the rules change when tax credits increase. Such industrial policy chooses favorites and drives out those less favorable companies.
The bottom line is that tax credits do not cause a state economy or a local economy to grow faster.
Let me leave you with the most important lesson I can: Economic growth comes from true innovation and creative imitation. Technological breakthroughs occur, and people tweak those breakthroughs until the law of diminishing returns renders the tweaking process unprofitable. No one has the magic crystal ball that perfectly predicts how or when such breakthroughs will occur. Taxpayer dollars are being invested in these industry winners through the tax credit program.
I am compelled to ask, what evidence do the officials have that they are better at picking the industry or company? Savers have skin in the investment game. Collectively, self-interested savers/financiers are better at identifying projects with the highest returns than well-intentioned government officials. Claims to the contrary amount to a kind of development snake oil.
Keeping income tax rates low and stable for everyone is certainly the best policy I know of that will promote such economic growth. Industrial policy in tax-credit clothing is not.