Rent-Seeking Behavior in the Illinois Wine Industry

February 22, 2010

Rent-Seeking Behavior in the Illinois Wine Industry

A plan pushed by Rep. Mike Bost, R-Murphysboro, could bolster a core of his district’s economy. Bost wants to create a fund that would go toward improving the region’s wine industry.

He’s proposing to divert a portion of the revenue from the excise tax on wine, and reinvest it in the industry. It’s classic rent-seeking behavior. He also uses the copycat argument (i.e, “other states are doing it, so mine should, too”) that many legislators use to justify production incentive programs for their favored industries.

“This is not anything that hasn’t been done in other states,” Bost said. “That is why the state of Missouri has grown its wine industry so well, and it’s because they are able to do this.”

Although it is true that Missouri provides assistance to wine producers, it does this in a manner that’s different than the one proposed in Illinois. Rather than diverting excise tax revenue, Missouri provides a generous tax credit to wine producers.

Using the “Show Me: Tax Credits” web tool, I discovered that Missouri has awarded $5,736,848.39 under the Wine and Grape Tax Credit during the past decade. The largest recipient, Stone Hill Wine Company, received a combined sum of $2,005,629.22 from 2002 through 2004:

Trend Wine and Grape Tax Credits Awarded in Missouri by Vendor

First and foremost, I disagree that a state should rely on tax credits to attract businesses. A state is better off if it has businesses that are self-sustaining, not reliant on government assistance.

That said, however, I prefer Illinois’ proposal to Missouri’s Wine and Grape tax credit program because it places the burden of the subsidy on users rather than on non-users. In Missouri’s program, all taxpayers in the state pay for the subsidy. In the Illinois proposal, only those who consume the product are assessed. It’s a user-fee system that’s analogous to the way in which gasoline taxes and tolls fund highway maintenance.

Additionally, it’s fallacious to expect that the production and consumption should be equal within the state. States like Missouri and Illinois should focus on the activities that they do best, and then realize the benefits of free interstate trade. If Illinois were serious about maximizing its wine consumption, it would specialize in some other type of production that it can do more efficiently, and then trade with another state that has a comparative advantage in producing wine.

Critics of the Illinois proposal are correct to state that the money being spent on wine production cannot be spent on other programs, such as education. However, the same can be said of the money that Missouri taxpayers spend via the wine and tax credit. No matter how it is routed, taxpayers are going to be poorer by the amount of the subsidy.

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It seems to me that your argument is predicated on the notion that the Missouri tax credit only benefits wineries. I presume that is also the case that Missouri’s wine industries attract a pretty fair chunk of cash from tourism and subsidiary industries associated with winemaking. The subsidy is revenue neutral if the amount of sales taxes raised through tourism and other subsidiary industries that now exist is equal to the amount of the subsidy.

Think of the state government as a retail store and the subsidy as a loss leader. Whether or not it works is contingent on a lot of actual calculation and is the real debate we should be having.

You also don’t understand that wine is a differentiated not a homogenous product so along at least part of the demand curve for wine are people who do not treat Missouri Norton as a substitute for Illinois Norton (at least theoretically) and certainly not as a substitute for New York riesling or Californian cabernet sauvignon. If consumers all displayed homogenous tastes then wine production would only make economic sense in certain regions.

Comment by Eapen Thampy — February 22, 2010 @ 4:36 p.m.
Spending taxpayer dollars on tourism benefits Missouri’s economy only at the expense of other state economies. I.e., officials hope to lure people’s largely fixed travel/leisure budgets to be spent here rather than elsewhere. Missouri is better off by the amount of tourism gained; other states are worse off by the amount of tourism lost. Society as a whole is poorer not only by the amount of the tourism subsidy (aggregated both from our state and others) but by the deadweight loss from market distortion that’s entailed in the very process of taxation.

Tourism spending is a losing game for everybody but the specific businesses that benefit somewhat less than the cost of everybody else’s loss.

Comment by Eric D. Dixon — February 22, 2010 @ 4:54 p.m.
Last night I opened the very last bottle of wine in my apartment and now I am experiencing the same kind of anxiety that Great Depression survivors probably experience when their cupboards are empty. That stated, I do understand that wine is a differentiated product.

I also understand that there there is a high selection of high-quality, competitively-priced imports from other states and from other countries. I’d rather drink water than Missouri wine because it’s too sweet for my tastes and also because I could get a Chilean Carmenère or a French Malbec for approximately the same price. The great thing about wine from California or from abroad is that Missouri taxpayers don’t have to subsidize its production.

Comment by Christine Harbin — February 22, 2010 @ 5:55 p.m.
Look, Eric, this is an empiric debate and I’m not well enough versed in this literature to know if anyone has actually tested these hypotheses. So in some sense we are both wrong without being able to refer to solid data.

The more fundamental problem with your argument is that we’re not dealing with an explicit subsidy, which is a direct transfer of wealth. That’s what the Illinoisians are debating. Missouri has a tax credit. This means that that we allow wineries to pay partial taxes and credit them for fully paying their taxes. There is no transfer here; rather, the tax credit is a tax cut. The problem with an excise tax is that it’s just a transfer of wealth and any government transfer of wealth has some marginal costs that are pure deadweight loss.

Comment by Eapen Thampy — February 22, 2010 @ 9:12 p.m.
Tax credits are an indirect transfer of wealth, which is no less a transfer because it’s indirect. If overall government spending doesn’t decrease by the amount of the credit (and it won’t), the effective marginal tax rate rises for other businesses and individuals.

Empirical data illuminates a pretty narrow range of economic questions. We can use it to estimate how much a particular industry might grow, or the amount of out-state dollars a credit might attract, even the future revenue a credit might provide to state coffers. It doesn’t help us determine full utility cost. I pointed out a couple of years ago that even hazarding a rough guess at personal utility cost for a decision as simple as whether to attend a concert at a smoky bar requires a type of counterfactual introspection that economists have no mechanism to access for even one person, let alone aggregate across entire populations. That’s why macroecon focuses on narrow considerations like GDP growth (and even those types of macro models are of pretty shaky scientific reliability).

As Frédéric Bastiat would quickly remind us, every economic action has effects both seen and unseen. We can measure the seen effects (growth of an industry, revenue confiscated, rates adjusted), but we can’t measure the unseen effects because they were prevented from occurring. Aggregate opportunity cost and interpersonal utility is impossible to measure at all, let alone accurately. Your insistence that this kind of policy debate remain rooted in empiricism — the few effects that have been observed and measured — is like trying to map a forest by examining a few tree trunks.

Ultimately, this is an a priori philosophical debate. Markets allow people to attempt to maximize their own utility by pursuing their own wildly divergent needs and interests. Government officials don’t have the ability to make better guesses than individuals acting in a freed market at what might better maximize aggregate utility. Central authorities don’t have better information about how to measure utility — they have worse. Any attempt by government officials to improve the economy through regulation or subsidy may make some small group of people better off, but it will always make other people worse off by a larger amount.

Comment by Eric D. Dixon — February 23, 2010 @ 2:31 p.m.
Your arguments against tax credits are generally applicable to all tax cuts since I read your response as a concession to that framework. This means for the purposes of this argument I get to leverage all the arguments why government should make tax cuts against your claim that you get to leverage all the arguments as to why indirect transfers of wealth are bad.

In an aggregate sense tax cuts increase the fiscal burden on governments appropriately prompting cuts in periods where governments face real fiscal constraints, like this one. Ultimately controlling spending might be as simple as limiting the number of elected officials, as David Stokes suggests.

I am much more critical really of your claim that we can’t compute actual estimates of the tax neutrality of this policy. To my knowledge this is precisely like government organizations like the CBO do. I can think of a variety of ways to compute estimates for this tax credit.

I have two arguments to throw at your last paragraphs:
1. Government officials don’t exist in a vaccuum: they are also individuals acting in free markets as citizens.
2. Your claim that central authorities don’t have better information about how to measure utility. I’ll note that this depends very specifically on the nature of the information necessary and how it is best aggregated and collected. Your claim is only true in specific situations and the general theory is less clear. I can provide a multiplicity of examples to demonstrate the absurdity of your last sentence. Ex: Attempts to improve the economy (or improve aggregate utility) through the regulation of nuclear reactors.

I was going to stop here, but then I read the Haslag et al article you linked to. It seems to me that generally speaking that logic is correct but doesn’t discuss the case in which tax credits stimulate consumer spending and the multiplier effect is greater than 1. Greg Mankiw writes:
“The size of the shift in aggregate demand resulting from a tax change is also affected by the multiplier and crowding-out effects. When the government cuts taxes and stimulates consumer spending, earnings and profits rise, which further stimulates consumer spending. This is the multiplier effect. (The multiplier effect for a tax change will be less than the multiplier effect of an equivalent change in government spending.)”

Mankiw elsewhere suggests:
“How can these empirical results be reconciled? One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment–a mechanism absent in the textbook Keynesian model.”

Comment by Eapen Thampy — February 23, 2010 @ 5:55 p.m.
Eapen, multipliers are meant to apply to a closed economy, so they aren’t relevant when dealing with a situation where tax credits are compensated by tourist spending. Moreover you have yet to make a case that wineries in particular deserve this type of subsidy. Indeed, and I think Eric will agree, such a case can not effectively be made.

Even if the presence of the subsidized wineries attracts more tourism spending and therefore more tourist tax dollars (already not an easy case to make) such subsidy misdirects Missouri resources into wine production that would otherwise be employed producing things desired by the market absent such a distortion.

Comment by Josh Smith — February 26, 2010 @ 12:45 p.m.

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It seems to me that your argument is predicated on the notion that the Missouri tax credit only benefits wineries. I presume that is also the case that Missouri’s wine industries attract a pretty fair chunk of cash from tourism and subsidiary industries associated with winemaking. The subsidy is revenue neutral if the amount of sales taxes raised through tourism and other subsidiary industries that now exist is equal to the amount of the subsidy.

Think of the state government as a retail store and the subsidy as a loss leader. Whether or not it works is contingent on a lot of actual calculation and is the real debate we should be having.

You also don’t understand that wine is a differentiated not a homogenous product so along at least part of the demand curve for wine are people who do not treat Missouri Norton as a substitute for Illinois Norton (at least theoretically) and certainly not as a substitute for New York riesling or Californian cabernet sauvignon. If consumers all displayed homogenous tastes then wine production would only make economic sense in certain regions.

Comment by Eapen Thampy — February 22, 2010 @ 4:36 p.m.

Spending taxpayer dollars on tourism benefits Missouri’s economy only at the expense of other state economies. I.e., officials hope to lure people’s largely fixed travel/leisure budgets to be spent here rather than elsewhere. Missouri is better off by the amount of tourism gained; other states are worse off by the amount of tourism lost. Society as a whole is poorer not only by the amount of the tourism subsidy (aggregated both from our state and others) but by the deadweight loss from market distortion that’s entailed in the very process of taxation.

Tourism spending is a losing game for everybody but the specific businesses that benefit somewhat less than the cost of everybody else’s loss.

Comment by Eric D. Dixon — February 22, 2010 @ 4:54 p.m.

Last night I opened the very last bottle of wine in my apartment and now I am experiencing the same kind of anxiety that Great Depression survivors probably experience when their cupboards are empty. That stated, I do understand that wine is a differentiated product.

I also understand that there there is a high selection of high-quality, competitively-priced imports from other states and from other countries. I’d rather drink water than Missouri wine because it’s too sweet for my tastes and also because I could get a Chilean Carmenère or a French Malbec for approximately the same price. The great thing about wine from California or from abroad is that Missouri taxpayers don’t have to subsidize its production.

Comment by Christine Harbin — February 22, 2010 @ 5:55 p.m.

Look, Eric, this is an empiric debate and I’m not well enough versed in this literature to know if anyone has actually tested these hypotheses. So in some sense we are both wrong without being able to refer to solid data.

The more fundamental problem with your argument is that we’re not dealing with an explicit subsidy, which is a direct transfer of wealth. That’s what the Illinoisians are debating. Missouri has a tax credit. This means that that we allow wineries to pay partial taxes and credit them for fully paying their taxes. There is no transfer here; rather, the tax credit is a tax cut. The problem with an excise tax is that it’s just a transfer of wealth and any government transfer of wealth has some marginal costs that are pure deadweight loss.

Comment by Eapen Thampy — February 22, 2010 @ 9:12 p.m.

Tax credits are an indirect transfer of wealth, which is no less a transfer because it’s indirect. If overall government spending doesn’t decrease by the amount of the credit (and it won’t), the effective marginal tax rate rises for other businesses and individuals.

Empirical data illuminates a pretty narrow range of economic questions. We can use it to estimate how much a particular industry might grow, or the amount of out-state dollars a credit might attract, even the future revenue a credit might provide to state coffers. It doesn’t help us determine full utility cost. I pointed out a couple of years ago that even hazarding a rough guess at personal utility cost for a decision as simple as whether to attend a concert at a smoky bar requires a type of counterfactual introspection that economists have no mechanism to access for even one person, let alone aggregate across entire populations. That’s why macroecon focuses on narrow considerations like GDP growth (and even those types of macro models are of pretty shaky scientific reliability).

As Frédéric Bastiat would quickly remind us, every economic action has effects both seen and unseen. We can measure the seen effects (growth of an industry, revenue confiscated, rates adjusted), but we can’t measure the unseen effects because they were prevented from occurring. Aggregate opportunity cost and interpersonal utility is impossible to measure at all, let alone accurately. Your insistence that this kind of policy debate remain rooted in empiricism — the few effects that have been observed and measured — is like trying to map a forest by examining a few tree trunks.

Ultimately, this is an a priori philosophical debate. Markets allow people to attempt to maximize their own utility by pursuing their own wildly divergent needs and interests. Government officials don’t have the ability to make better guesses than individuals acting in a freed market at what might better maximize aggregate utility. Central authorities don’t have better information about how to measure utility — they have worse. Any attempt by government officials to improve the economy through regulation or subsidy may make some small group of people better off, but it will always make other people worse off by a larger amount.

Comment by Eric D. Dixon — February 23, 2010 @ 2:31 p.m.

Your arguments against tax credits are generally applicable to all tax cuts since I read your response as a concession to that framework. This means for the purposes of this argument I get to leverage all the arguments why government should make tax cuts against your claim that you get to leverage all the arguments as to why indirect transfers of wealth are bad.

In an aggregate sense tax cuts increase the fiscal burden on governments appropriately prompting cuts in periods where governments face real fiscal constraints, like this one. Ultimately controlling spending might be as simple as limiting the number of elected officials, as David Stokes suggests.

I am much more critical really of your claim that we can’t compute actual estimates of the tax neutrality of this policy. To my knowledge this is precisely like government organizations like the CBO do. I can think of a variety of ways to compute estimates for this tax credit.

I have two arguments to throw at your last paragraphs:
1. Government officials don’t exist in a vaccuum: they are also individuals acting in free markets as citizens.
2. Your claim that central authorities don’t have better information about how to measure utility. I’ll note that this depends very specifically on the nature of the information necessary and how it is best aggregated and collected. Your claim is only true in specific situations and the general theory is less clear. I can provide a multiplicity of examples to demonstrate the absurdity of your last sentence. Ex: Attempts to improve the economy (or improve aggregate utility) through the regulation of nuclear reactors.

I was going to stop here, but then I read the Haslag et al article you linked to. It seems to me that generally speaking that logic is correct but doesn’t discuss the case in which tax credits stimulate consumer spending and the multiplier effect is greater than 1. Greg Mankiw writes:
“The size of the shift in aggregate demand resulting from a tax change is also affected by the multiplier and crowding-out effects. When the government cuts taxes and stimulates consumer spending, earnings and profits rise, which further stimulates consumer spending. This is the multiplier effect. (The multiplier effect for a tax change will be less than the multiplier effect of an equivalent change in government spending.)”

Mankiw elsewhere suggests:
“How can these empirical results be reconciled? One hypothesis is that that compared with spending increases, tax cuts produce a bigger boost in investment demand. This might work through changing relative prices in a direction favorable to capital investment–a mechanism absent in the textbook Keynesian model.”

Comment by Eapen Thampy — February 23, 2010 @ 5:55 p.m.

Eapen, multipliers are meant to apply to a closed economy, so they aren’t relevant when dealing with a situation where tax credits are compensated by tourist spending. Moreover you have yet to make a case that wineries in particular deserve this type of subsidy. Indeed, and I think Eric will agree, such a case can not effectively be made.

Even if the presence of the subsidized wineries attracts more tourism spending and therefore more tourist tax dollars (already not an easy case to make) such subsidy misdirects Missouri resources into wine production that would otherwise be employed producing things desired by the market absent such a distortion.

Comment by Josh Smith — February 26, 2010 @ 12:45 p.m.

February 22, 2010