Audit Confirms What Show-Me Institute Scholars Have Said All Along: Tax Credits Are Overhyped
On Monday, Missouri State Auditor Susan Montee released a study of tax credit cost controls. The audit’s conclusions have been covered by the media, as well as on Show-Me Daily. The audit seems to affirm much of the Show-Me Institute’s scholarly work on tax credits; it reports that the economic impact of tax credits is routinely overestimated and their costs underestimated. Some key findings from the audit are outlined below:
Fiscal notes tended to understate the cost of tax credits, some of which underwent further expansions after their initial passage. Of the 15 tax credits reviewed, the fiscal notes underestimated their total cost by $1.1 billion over a five year period. This is not surprising given the tendency that Show-Me Institute research assistant John Payne noted for politicians to overestimate the impact of their policies and underestimate the costs.
Four of the five tax credit programs for which fiscal notes underestimated the amount that the credits would disperse were new. They had lower participation than expected, as well as annual limits on the amount that could be redeemed. (See page 8 of the audit for a table displaying the projected and actual costs for all 15 of these tax credit programs.)
The audit notes that the short time frame — three years — of the cost estimates limits their ability to predict long-term effects. On the flip side, the audit also notes that even longer estimates are inaccurate and unable to predict true costs. Given that the fiscal notes had poor predictive power, the audit suggests that limits and sunset clauses may be necessary methods to limit the costs of tax credits.
Annual or Cumulative Limits
Annual or cumulative limits cap the amount of tax credits that can be redeemed from any particular program. This is one measure that the audit suggests be put into place for all tax credits, although 23 of the 53 programs redeemed in 2009 did not have annual or cumulative limits.
Some tax credit programs have seen their limits increased substantially, like the Missouri Quality Jobs program, which initially had a $12 million annual limit and currently has a $80 million limit. Officials’ ability to increase these limits through committees or departments, without having to go through the full legislative process, circumvents the purpose of limits.
In 2003, Missouri passed the Sunset Act, which stipulated that each program must be reauthorized after six years. This allows the economic impact to be evaluated before further extensions are granted. Of the 18 tax credit programs passed after 2003, only 10 have sunset provisions. The audit suggests that sunset provisions be included in every new tax credit.
Conclusions From the Audit
Sunsets and both annual and cumulative limits could substantially control the cost of tax credits. As the audit points out, it is difficult to predict the long-term effects of specific tax credits; with a sunset provision, the effects are reviewed and evaluated before a program is continued. Annual and cumulative limits would hold tax credits to the amount specified by the bill, which would discourage underestimates as well as control tax credit expenditures. Currently accounting for 7.8 percent of the 2009 Missouri budget, tax credits will continue to grow if cost-control measures are not better implemented.
How has the legislature responded to the audit’s pronouncement on tax credits? The speaker of the House issued a press release disagreeing with its conclusions:
“Auditor Susan Montee and Governor Jay Nixon are playing a dangerous and damaging political game creating a fictitious conflict between education and Missouri jobs. Education and economic development are mutually beneficial, not mutually exclusive,” [the speaker] stated. “In the House, we have always welcomed independent, objective scrutiny on how to best reform and enhance tax credit programs. Missourians need jobs. Therefore, the Missouri House will continue to protect responsible economic development programs that create those jobs. And we will have the last word on this matter.”
With all of the evidence that tax credits cost more than anticipated with less impact than predicted, greater scrutiny is warranted before the state considers passing any further credits. The audit brings to light important issues that proponents of tax credits must face in order to bring greater fiscal responsibility to Missouri’s budget.
Aside from the audit’s careful consideration of the unforeseen costs that tax credits entail, it’s also important to consider some of the broader economic reasons that such targeted industry credits are not as effective as their proponents suggest. As Show-Me Institute scholars have repeatedly pointed out, tax credits are less efficient than lower tax rates, both because legislators have no special talent for picking winners and losers in the economy, and because the credits distort economic incentives, causing a misallocation of capital subsidized producers have an incentive to produce more than is efficient, and some other set of unsubsidized goods or services are slightly underproduced as a result.
Perhaps this audit will encourage a the legislature to consider lower tax rates in lieu of inefficient tax credits.