Tax Credits Are an Undesirable Strategy for Missouri

There was some classic rent-seeking behavior in the editorial section of the Post-Dispatch yesterday: An architect touts historic preservation tax credits. (Thanks to John Combest for the link.) According to his tagline, the author “has worked on many renovation projects on Washington Avenue,” a location that has received many of these tax credits. We witness this type of behavior all too frequently in Missouri — in the film industry, in the local agriculture industry, in the dental industry, etc. Although the actors may change, the plot remains the same: One group asks the government to adopt policies (e.g., tax credits, occupational licenses) that would benefit that group only, and at the expense of all other groups.

I want to take this opportunity to present arguments against the claims that the author made, and also to explain how tax credits are undesirable policy for Missouri. The author of the editorial states:

The tax-credit program may need fine tuning, but it is too important for St. Louis and Missouri to scale back — especially in difficult economic times.

The state can least afford giving tax credits to select firms and businesses during difficult economic times. Tax credit programs place an additional burden on taxpayers who are already hurting in difficult economic times. I don’t know whether the author has heard, but Missouri is out of money! Many other programs compete for these funds, so the government and taxpayers face an opportunity cost equal to the amount of the tax credit. Additionally, because unredeemed tax credits represent a future liability, they will negatively affect a state’s ability to recover from difficult economic times when it has to dole out money at unexpected intervals in the future.

Tax credits are used as a powerful tool for economic development all across the state, not only creating a considerable number of jobs but also providing many social benefits.

According to a study of tax credit cost controls recently released by Missouri State Auditor Susan Montee, tax credits have less of an impact than predicted and cost more than anticipated. The report reviewed 15 major tax credit programs in Missouri, and found that the fiscal notes underestimated the total cost of the programs by $1.1 billion over a five-year period. For the historic preservation tax credit — the one for which the author specifically lobbies — the redemptions far exceed the estimated fiscal impact. From the audit report (emphasis mine):

[T]he fiscal notes accompanying Senate Bill 1 of the 1997 2nd Extraordinary Session, that established the historic preservation tax credit, estimated an annual fiscal impact of $14.3 million. The only other legislation impacting this credit through the 2008 legislative session was Senate Bill 827 in 1998 and the fiscal note for that bill indicated the impact of the statutory change was unknown. Based upon our methodology, the projected fiscal impact was $14.3 million annually and $71.5 million over the 5 year period, while redemptions totaled over $637 million.

This trend is not specific to tax credits for historic preservation; many other tax credit programs also fail to live up to their hype. For example, Missouri subsidizes the film industry with tax credits, but there have been fewer people employed in the industry since the tax credit program began.

Furthermore, targeted tax credits discourage economic development in the state by hurting businesses in non-favored industries. By providing special advantages to a select industry, targeted tax credits force everyone else in the market to compete at a disadvantage. An uneven playing field is not an optimal economic climate for fostering development.

A particular program may provide some social benefits, but the state has to weigh this against the marginal cost of devoting money to a particular project. The state needs to consider those competing needs carefully, because resources are scarce.

Quoting again from the Post-Dispatch editorial:

The ability of tax credits to create jobs and generate economic activity has been recognized by some of our neighboring states. Kansas has removed its cap on tax credits, and Nebraska increased its cap by $30 million.

If all of the other states jump off a bridge, should Missouri jump, too?

The great thing about the state system is that they function as living laboratories. Policymakers can observe the effects of policies in other states, determine whether they are successful, and decide whether these policies should be incorporated into their own states. Observing the effects of tax credit programs reveals that they do not result in their stated purposes, and spending more on them is unlikely to result in better outcomes.

Tangentially, a big downside to the editorial is the author’s lack of focus; he talks about tax credits for historic preservation in places, then talks about general tax credit programs in others. In the above quotation, the author seems to speak of tax credits in general, although this is unclear. In reality, Missouri issues more tax credits for historic buildings than any other state in the nation. Virginia issues the second most, but spends only half as much on them as Missouri.

But many of these developments would not be feasible without tax credits. […] The Washington Avenue loft district would not have happened without the tax credit program. […] The renovation of the Chase Park Plaza complex would never have taken place without the historic preservation tax credits. Tens of millions of dollars were invested in the project. […] Without the credits, significant private investment [in the Forest Park Southeast neighborhood] would not have been made.

Here, the author fails to consider the direct and indirect consequences that may have come into existence had the taxpayers of Missouri been allowed to keep their millions. The Chase Park Plaza and a renovated historical building are easily seen effects; however, the products and services that would have otherwise been consumed in the private sector represent the unseen effects. The tens of millions of dollars that were invested in the Chase Park Plaza were taken away from taxpayers who would otherwise have spent it on the products and services that they needed and wanted most. As Henry Hazlitt explains in Economics in One Lesson, for every public job created by the Chase Park Plaza (or historic preservation on Washington Avenue), a job has been destroyed in the private sector. Development is easy to see, but the unseen includes the jobs that were destroyed because the money that would have funded them was appropriated for other uses.

At a news conference, Gov. Nixon acknowledged that the state tax credit program is used “for good and solid purposes.” Last year, he was even promoting the expansion of tax credits for businesses, claiming it was essential for Missouri’s economy.

Yes, but the governor has also called for tax credit cuts. As an illustration of his support for cutting tax credits, the Associated Pressed dubbed him “cutter-in-chief.” In this regard, the governor sends a mixed message.

[T]hey are not giveaways.

Tax credits operate by reducing the recipient’s individual or corporate income tax bills. By reducing the tax burden of a single targeted industry or company, if overall government spending is not also reduced by the amount of that credit, the marginal tax rate for everybody else increases. This shifting of the tax burden from one party to others is certainly a type of giveaway. In addition, the fact that many of these tax credits are transferable means that they can be sold on a secondary market. Consequently, tax credits can ultimately benefit individuals who have nothing to do with the rationale for their issuance.

Much has been made of the tax credits costing the state $585 million last year — up 57 percent since 2001. This only indicates the program is working well.

If the Missouri Department of Economic Development were successful in developing the economy, it would eliminate the need for its own existence. That obviously hasn’t happened. However, if by “working well” the author means creating a system of corporate welfare, then I agree.

But lost revenue can be made up many times more by economic activity not otherwise generated. This means additional tax dollars for schools and essential services.

Tax credit programs are growing at a much faster rate than the state’s revenues, as communicated in the Missouri state auditor’s report on tax credits. This is not a sustainable trend, because continuing at this rate would eventually lead to the state issuing more money in tax credits than it takes in as revenue. From fiscal year 2001 to fiscal year 2009 in the state of Missouri, tax credit redemptions increased by 57 percent, while net general revenue fund collections increased by only 15.7 percent.

Additionally, many of these tax credits include property tax abatements, which means that the local and state government will receive no tax revenue from the new business. The new IBM service center in Columbia is a recent example.