Tax Incentives Are a Game We Can’t Win

June 24, 2010

Tax Incentives Are a Game We Can’t Win

Today, Show-Me Institute Research Analyst Christine Harbin appeared on the Sarah Steelman Hour radio show in Springfield, talking about tax credits in general and, specifically, the proposed credits for the Ford plant in Claycomo.

Economic development tax incentives, no matter how they are packaged, are not effective. They allow government officials, who have no special knowledge of how to maximize growth, to pick winners and losers in the market. As Show-Me Institute Executive Vice President Joseph Haslag has written before, lowering broad tax rates is a much more efficient method of stimulating the economy than targeted tax credits. This allows everyone to benefit, rather than a few select industries chosen by the state.

Empirically, studies analyzing the benefits that development tax credits deliver in comparison to their costs show that such tax credits have not worked. A recent Missouri state audit report found that tax credits are less effective (and more expensive) than their proponents claim. Yesterday, St. Louis Public Radio broadcast a segment featuring a study that examined another form of tax incentives in Missouri, tax increment financing (TIF). Kenneth Thomas, a political science professor at the University of Missouri–St. Louis, recently coauthored a study that found the use of TIF is not effective in most cases. He noted that the St. Louis area uses TIF more than nearly every other area in the nation. In the interview with St. Louis Public Radio’s Matt Sepic:

Sepic: That’s one longstanding criticism, is that TIF pits communities against one another. A prime example is that tussle between Bridgeton and St. Anne over a Walmart. Is that a bigger problem in the St. Louis area than elsewhere, with this panoply of municipalities that we have here?

Thomas: Oh, yes, certainly having more municipalities makes the competition more intense.

The study argues that, although many economists have found TIF to be ineffective, this method of funding continues to be used because of the competitive nature of tax incentives. When one area offers a tax incentive, other areas nearby often try to “win” a company’s business by offering competitive tax incentives. The result is a bidding war in which the taxpayers lose. This can be seen in the Claycomo Ford tax credit situation, as well — other states, like Kentucky, have offered tax incentives to Ford in an effort to persuade them to relocate their plant. In order to compete, Missouri would have to offer a better deal, while recognizing that this game will be played again the next time the credits run out.

Later in the interview, Thomas notes an important misunderstanding — the idea that tax incentives like TIF “create” jobs:

Thomas: [T]hose estimates never take into account the fact that, well, yes, we are going to create 200 jobs here, but what’s going to happen is we’re going to knock out 180 in the next mall over.

Tax credits and TIF tend to shift economic activity from one area to another, without creating wealth. Missouri’s tax dollars would be much better spent in the hands of individual Missourians than on enticements for companies like Walmart or Ford.

As Milton Friedman pointed out on his PBS TV series “Free to Choose,” even if other nations, states, or localities offer tax incentives to lure businesses, we’re better off if we don’t do the same — because we benefit from the lower prices their subsidy creates. Missouri will experience better economic growth if it unilaterally removes itself from the tax incentive bidding wars.

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5 Comments »

TIF and tax credits are not the same. You should not bring up TIF or that study regarding this plant in Columbia. The TIF study’s most significant findings were regarding competing municipalities. St. Louis County’s “maximum choice,” fragmentation, and TIF abuse, results from economist Charles Tiebout’s application of neoliberial market extremism onto public service delivery, as well as suburban sprawl.

Moreover, the idea that government picks winners and losers happens to be a joke. Libertarianism would only be corporate anarchy and even greater capture among a reduced government body. If anything TIF would increase as a weaker government would have reduced power to say no as fewer access points exist for citizens to object and be involved. Finally, the people, through government, have an obligation to pick certain winners and choosers if their job or entire town happens to be at stake. Or perhaps we should remove all trade barriers and subsidy flooding our borders with cheap foreign goods increase unemployment and maximizing suicides? Wait, that would be what Milton et al did to South America, Asia, and Eastern Europe through structural adjustment!

Comment by Douglas Duckworth — June 29, 2010 @ 12:03 p.m.
Doug,

What precisely are you saying?

I think that government did pick a winner with that new grocery store downtown…

no?

Comment by Thomas Duda — June 29, 2010 @ 12:11 p.m.
Thanks for your comment, Douglas. TIFs and tax credits are both tax incentives that the government can use to help a specific business or individual that they choose. I included studies in my argument that show that both types are not effective. (The TIF study notes that many other economists have found TIFs to be ineffective; the audit report found the tax credit claims have been overblown and far more expensive for the taxpayers than initially explained.) It would be best to lower the broad tax base to help all individuals and businesses, instead of just politically connected individuals or businesses. Do you disagree with the empirical argument against favoring select industries, or the theoretical one?

I’m not sure I understand your argument. Right now, the government has the power to take tax dollars and give them to specific corporations. The government gets to choose which businesses receive the taxpayers’ dollars and which businesses do not. I’m not sure how one could argue that there could be an even greater capture than the government simply handing businesses billions of the taxpayers’ dollars. Perhaps your argument might make more sense on a topic other than tax credits (though I’d be happy to discuss at another point why that still wouldn’t hold true). But on the topic of tax credits, your argument does not make sense.

Tax credits help the targeted “seen” businesses and individuals who keep their jobs, but hurt the “unseen” individuals and businesses who have less money to create jobs or spend in other sectors of the economy. (Henry Hazlitt’s Economics in One Lesson explains this in further detail.)

Perhaps no one has clearly articulated the libertarian/free-market/classical liberal philosophy to you before; you probably agree with it more than you believe. Governmental involvement necessarily gives corporations and big business more power… this is a bad thing. Governments create barriers to entry, which prevent others from competing with those favored businesses. They give favored industries the public’s money. Big businesses like these tax credits, barriers, tax increment financing, etc., because they are able to capture far more market share than they could if they had to compete in a free and open market (or what you might call “corporate anarchy”).

Libertarianism/classical liberalism is a very nuanced philosophy, which I would be more than happy to talk with you about in detail at a later point or point you to some good essays and books explaining the mechanisms behind it. I think you would benefit from our book club discussions, where we discuss these sorts of issues and can address your disagreements in further detail. Our next meeting is on Wednesday, July 14, and we are reading the The Ultimate Resource 2. (Email our editor, Eric, for more information.)

Hope to see you there!

Comment by Caitlin Hartsell — June 29, 2010 @ 12:53 p.m.
Barriers to entry like subsidy and regulations also protect jobs — small and large business — from leaving one geographic region like town, state, or country. They also protect small domestic businesses from being overtaken by cheaper foreign goods, as I referenced with structural adjustment or as we know the Washington Consensus. Personally I would rather have a dead-weight loss over higher unemployment rates and suicides — we saw in the Southern Cone to Russia when those policies were implemented by people like Jeff Sachs. I support spending public dollars keeping our manufacturing in tact as opposed to what we’ve seen across the Rustbelt.

How does keeping an auto plant open harm unseen businessmen? Like the service sector business owners which support those workers? Do you know what Natural Bridge was like before GM relocated to Wentzville?

Comment by Douglas Duckworth — June 29, 2010 @ 6:14 p.m.
It’s easy to “see” the auto industry (and even those service industries connected to it) because those are jobs concentrated in one area. It is much harder to see the jobs that other businesses could have created if other businesses had lower tax rates and were thus able to employ more people.

Unfortunately, the companies that tend to get these protectionist aid tend to be less efficient than other industries, which is part of the reason why they lobby for it in the first place. It stands to reason, then, that the money is not used as efficiently as it would have been by the original taxpayers or businesses if they had expanded their own payrolls, or had more money to spend on goods for themselves. If individuals allocate the money themselves, it goes towards sectors that the public values more. Why should we all pay more for Ford to make cars, especially if more people want to drive a Honda? The government is ill-equipped to choose the “right” industries to which to distribute money.

Your argument is that protectionism is good because it keeps people employed. Even if we grant all your premises, we can see that this protectionism hasn’t worked in the U.S. The steel industry and auto industries get tariffs, subsidies, etc. and they are still hemorrhaging jobs. What is the result? Cars and steel are more expensive, and the taxpayers have fewer dollars to spend to create jobs in other sectors of the economy (places where, if they had a lower tax rate, more jobs could be created). And some of the jobs that we spend so much money trying to protect are still disappearing. Protectionist policy leads to more unemployment, and if we follow your logic, more suicides.

So, will we have fewer auto workers in Missouri if Ford decides to leave? Maybe. But will other businesses be able to expand their payrolls if their tax rates were lower after the state stopped handing out tax incentives to favored industries? Yes, but these jobs are more diffuse and spread across the state, and therefore harder to point to.

(I’ll point you to our case study about Tennessee’s higher economic growth than Missouri’s. It’s an interesting point to ponder.)

Trade makes everyone better off. When goods are cheaper (like, when they come from a foreign country) people have more purchasing power. This raises the standard of living across the board. When taken over generations, these protectionist policies severely hamper the quality of life for future generations.

We can see empirically that these protectionist policies are not as effective as they pretend to be: American cars are more expensive, and people are still losing jobs in that sector. It takes a lot of money to prop up industries that cannot compete on their own, money that, if left in other sectors, would translate to even more jobs than those in the protected sectors. (Really, if you haven’t read it yet, Henry Hazlitt’s Economics in One Lesson is worth reading. He explains this phenomenon very clearly.)

Also, though this is not a topic that Show-Me Daily deals with, Naomi Klein’s portrayal of Milton Friedman is ahistorical and inaccurate, and thus not a convincing example.

Comment by Caitlin Hartsell — June 30, 2010 @ 2:04 p.m.

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TIF and tax credits are not the same. You should not bring up TIF or that study regarding this plant in Columbia. The TIF study’s most significant findings were regarding competing municipalities. St. Louis County’s “maximum choice,” fragmentation, and TIF abuse, results from economist Charles Tiebout’s application of neoliberial market extremism onto public service delivery, as well as suburban sprawl.

Moreover, the idea that government picks winners and losers happens to be a joke. Libertarianism would only be corporate anarchy and even greater capture among a reduced government body. If anything TIF would increase as a weaker government would have reduced power to say no as fewer access points exist for citizens to object and be involved. Finally, the people, through government, have an obligation to pick certain winners and choosers if their job or entire town happens to be at stake. Or perhaps we should remove all trade barriers and subsidy flooding our borders with cheap foreign goods increase unemployment and maximizing suicides? Wait, that would be what Milton et al did to South America, Asia, and Eastern Europe through structural adjustment!

Comment by Douglas Duckworth — June 29, 2010 @ 12:03 p.m.

Doug,

What precisely are you saying?

I think that government did pick a winner with that new grocery store downtown…

no?

Comment by Thomas Duda — June 29, 2010 @ 12:11 p.m.

Thanks for your comment, Douglas. TIFs and tax credits are both tax incentives that the government can use to help a specific business or individual that they choose. I included studies in my argument that show that both types are not effective. (The TIF study notes that many other economists have found TIFs to be ineffective; the audit report found the tax credit claims have been overblown and far more expensive for the taxpayers than initially explained.) It would be best to lower the broad tax base to help all individuals and businesses, instead of just politically connected individuals or businesses. Do you disagree with the empirical argument against favoring select industries, or the theoretical one?

I’m not sure I understand your argument. Right now, the government has the power to take tax dollars and give them to specific corporations. The government gets to choose which businesses receive the taxpayers’ dollars and which businesses do not. I’m not sure how one could argue that there could be an even greater capture than the government simply handing businesses billions of the taxpayers’ dollars. Perhaps your argument might make more sense on a topic other than tax credits (though I’d be happy to discuss at another point why that still wouldn’t hold true). But on the topic of tax credits, your argument does not make sense.

Tax credits help the targeted “seen” businesses and individuals who keep their jobs, but hurt the “unseen” individuals and businesses who have less money to create jobs or spend in other sectors of the economy. (Henry Hazlitt’s Economics in One Lesson explains this in further detail.)

Perhaps no one has clearly articulated the libertarian/free-market/classical liberal philosophy to you before; you probably agree with it more than you believe. Governmental involvement necessarily gives corporations and big business more power… this is a bad thing. Governments create barriers to entry, which prevent others from competing with those favored businesses. They give favored industries the public’s money. Big businesses like these tax credits, barriers, tax increment financing, etc., because they are able to capture far more market share than they could if they had to compete in a free and open market (or what you might call “corporate anarchy”).

Libertarianism/classical liberalism is a very nuanced philosophy, which I would be more than happy to talk with you about in detail at a later point or point you to some good essays and books explaining the mechanisms behind it. I think you would benefit from our book club discussions, where we discuss these sorts of issues and can address your disagreements in further detail. Our next meeting is on Wednesday, July 14, and we are reading the The Ultimate Resource 2. (Email our editor, Eric, for more information.)

Hope to see you there!

Comment by Caitlin Hartsell — June 29, 2010 @ 12:53 p.m.

Barriers to entry like subsidy and regulations also protect jobs — small and large business — from leaving one geographic region like town, state, or country. They also protect small domestic businesses from being overtaken by cheaper foreign goods, as I referenced with structural adjustment or as we know the Washington Consensus. Personally I would rather have a dead-weight loss over higher unemployment rates and suicides — we saw in the Southern Cone to Russia when those policies were implemented by people like Jeff Sachs. I support spending public dollars keeping our manufacturing in tact as opposed to what we’ve seen across the Rustbelt.

How does keeping an auto plant open harm unseen businessmen? Like the service sector business owners which support those workers? Do you know what Natural Bridge was like before GM relocated to Wentzville?

Comment by Douglas Duckworth — June 29, 2010 @ 6:14 p.m.

It’s easy to “see” the auto industry (and even those service industries connected to it) because those are jobs concentrated in one area. It is much harder to see the jobs that other businesses could have created if other businesses had lower tax rates and were thus able to employ more people.

Unfortunately, the companies that tend to get these protectionist aid tend to be less efficient than other industries, which is part of the reason why they lobby for it in the first place. It stands to reason, then, that the money is not used as efficiently as it would have been by the original taxpayers or businesses if they had expanded their own payrolls, or had more money to spend on goods for themselves. If individuals allocate the money themselves, it goes towards sectors that the public values more. Why should we all pay more for Ford to make cars, especially if more people want to drive a Honda? The government is ill-equipped to choose the “right” industries to which to distribute money.

Your argument is that protectionism is good because it keeps people employed. Even if we grant all your premises, we can see that this protectionism hasn’t worked in the U.S. The steel industry and auto industries get tariffs, subsidies, etc. and they are still hemorrhaging jobs. What is the result? Cars and steel are more expensive, and the taxpayers have fewer dollars to spend to create jobs in other sectors of the economy (places where, if they had a lower tax rate, more jobs could be created). And some of the jobs that we spend so much money trying to protect are still disappearing. Protectionist policy leads to more unemployment, and if we follow your logic, more suicides.

So, will we have fewer auto workers in Missouri if Ford decides to leave? Maybe. But will other businesses be able to expand their payrolls if their tax rates were lower after the state stopped handing out tax incentives to favored industries? Yes, but these jobs are more diffuse and spread across the state, and therefore harder to point to.

(I’ll point you to our case study about Tennessee’s higher economic growth than Missouri’s. It’s an interesting point to ponder.)

Trade makes everyone better off. When goods are cheaper (like, when they come from a foreign country) people have more purchasing power. This raises the standard of living across the board. When taken over generations, these protectionist policies severely hamper the quality of life for future generations.

We can see empirically that these protectionist policies are not as effective as they pretend to be: American cars are more expensive, and people are still losing jobs in that sector. It takes a lot of money to prop up industries that cannot compete on their own, money that, if left in other sectors, would translate to even more jobs than those in the protected sectors. (Really, if you haven’t read it yet, Henry Hazlitt’s Economics in One Lesson is worth reading. He explains this phenomenon very clearly.)

Also, though this is not a topic that Show-Me Daily deals with, Naomi Klein’s portrayal of Milton Friedman is ahistorical and inaccurate, and thus not a convincing example.

Comment by Caitlin Hartsell — June 30, 2010 @ 2:04 p.m.

June 24, 2010