Tax Credits as a Tool of State Economic Development Policy

Tax incentives are among the main instruments of state and local economic development policy, and tax credits are among the most prevalent types of tax incentive. Tax credits come in many forms and serve an array of purposes, although economic development is central to their existence. The purpose of this paper is to summarize the findings in the economics literature on the effectiveness of state tax credits in spurring economic development.

The context for this survey is the establishment of an official commission to review Missouri’s tax credit programs with the purpose of streamlining and consolidating the state’s myriad tax credit programs. The commission’s efforts are certainly worthy, and its report contains many eminently sensible suggestions, but its proceedings avoided the extremely important question of whether or not the tax credits have been, or even can be, effective. This survey is a contribution to a clearer understanding of this issue.

The remainder of this paper surveys the state of the academic literature regarding the effectiveness of economic development incentives, with particular attention paid to state tax credits. The next two sections describe the basic structure of tax credits and their use in Missouri. Sections 4 and 5 discuss the use of development incentives in general, first outlining the economic efficiency arguments in their favor and then summarizing the literature estimating their effects. Section 6 describes the literature dealing specifically with the effects of tax credits, and the final section provides three broad conclusions drawn from this literature.