The 2007 economic development bill, HB 327, would enact a wide variety of tax credits and other subsidies. Although widely praised in the press and by favored industries, the bill — now awaiting the governor’s signature — has two crucial problems. First, it rests on the notion that Missouri bureaucrats need to become more involved in identifying industries, types of employment, and goods and services that should be encouraged. Second, the bill ignores the government budget constraint. Revenue lost to tax breaks for favored industries would need to be recouped by reduced government spending, or — more likely — imposing a higher marginal tax rate on other industries.
In addition to tax credits, the state has engaged in industrial policy by creating a panel to advise the Department of Economic Development. According to the February press release, the panel is organized to help direct the Missouri economy in certain key industries: life sciences, energy, defense and homeland security, transportation and logistics, and information technology. If allowed to spread, such target-industry policies will be the economic equivalent of kudzu — a fast-growing vine spreading through the southeastern states — choking off the real sources of economic development.
The existence of market failures may provide an economic justification for tax credits or industrial policy. However, no such arguments are made by those sponsoring this legislation. What market failures have affected beef cattle and aviation jet fuel? Rather, the subsidies and tax credits distort investment choices, so that resources will be artificially directed to these activities and away from economic opportunities that make real economic sense, and would result in faster growth.
Missouri has lagged behind other states since 1995, missing the productivity spurt that pushed the U.S. economy forward, but a centralized approach to economic planning is the wrong course to take. Efforts by other state governments to effectively “guide” economic policy have been largely ineffectual. Something as complex as an economy, even at state level, naturally resists any attempt at guidance by central planners. Remember the Soviet Union?
Economic growth doesn’t stem from bureaucratic control. Ultimately, economic development comes from the new ideas that are created and brought to the marketplace. The source of these ideas is as large as the earth’s population. Entrepreneurs step up to satisfy the market demands around them. These ideas come from a variety of sources, ranging from those cultivated by basic research and development undertaken by private firms to ones dreamed up in a household kitchen.
Luring this economic activity to Missouri requires a business climate that yields returns for successful ideas through secure property rights and low overall business transaction costs. Because of the incentives operating in the market, ideas will be vetted. The evidence is clear: the people in government have neither the information nor incentives to vet ideas as efficiently as the market. Trying to pick economic winners based on the experience and wisdom of a few state-appointed people attempting to guess the future demands of private citizens is a formula for failure.
Offering official encouragement to any set of groups or industries imposes economic costs that may not be immediately obvious. There is a fundamental tradeoff between tax credits and deductions for favored parties, and marginal tax rates. State governments face a budget constraint. Accordingly, the more deductions for one set of transactions, the higher the rates for unfavored transactions — a source of significant economic damage that tends to drive such activities out of Missouri to other states. To offset revenue lost to through tax credits, the state must raise revenue from other sources. Higher tax rates stifle economic activity that would otherwise have stayed in Missouri, thus resulting in lower income and growth in our state. This bill is misnamed. A better economic development bill would reduce these corporate giveaways, simplify the tax system, and reduce marginal tax rates. Missouri households and businesses can create their own “quality jobs” without the help of state government.
Government economic planners do not know what the next “big idea” will be, and any effort to find that idea through central intervention is likely to fail. The best way for Missouri to ensure future economic prosperity is to provide businesses with a climate favorable to developing those ideas, whatever they may be. State officials should step back from the belief that they can fix weak economic growth through central planning. Creating another layer of bureaucracy, no matter how well-intentioned, will only obstruct those developments and, like kudzu to southeast horticulture, choke off Missouri’s economic growth.
Joe Haslag is a professor of economics at University of Missouri-Columbia. Michael Podgursky is a professor of economics at University of Missouri-Columbia, where he served as department chair from 1995 to 2005. Both are Show-Me Institute scholars. Steve Bernstetter is an intern at the Show-Me Institute.