JLF: End Targeted Corporate Tax Incentives
RALEIGH -— North Carolina lawmakers would harm, not help, the state’s economic growth if they extend and expand corporate tax incentive programs. That’s the key conclusion from a new John Locke Foundation Spotlight report.
“The problem with these kinds of policies is that, even though they are promoted under the rubric of ‘economic development,’ there are no sound economic arguments to be made on their behalf,” said report author Dr. Roy Cordato, JLF Vice President for Research and Resident Scholar. “In fact, economic analysis suggests that they are likely to harm consumers, investors, and entrepreneurs who are not privy to the incentives.”
Cordato, a Ph.D. economist, releases the report as Gov. Pat McCrory and state legislators debate proposals to continue the existing Job Development Investment Grant program in some form. The debate also extends to special tax breaks for building preservation, renewable energy, and the movie industry.
“Support for tax and spending subsidies to attract business to North Carolina is based on what is quite likely the oldest and most common economic fallacy ever invoked, namely that the only economic effects that count are those that are obvious and visible,” Cordato said.
The report offers a hypothetical example of using incentives to lure an auto manufacturing plant from Ohio to North Carolina. The highly visible move would generate positive media coverage. Incentive supporters would consider any jobs tied to the plant as a positive economic benefit.
This approach is flawed, Cordato explains. “By examining only the economic effects of what can be seen and then counting all of those impacts as benefits, rather than trying to differentiate benefits from costs, there can be no downside to these subsidy programs,” he said. “This assumes that labor and other resources being used by the subsidized company would otherwise lay idle. There is no consideration that what is being subsidized is actually displacing economic activity that would otherwise be occurring.”
In other words, incentives supporters ignore the saying “There’s no free lunch,” Cordato said. “That saying is based on the bedrock economic principle of scarcity, which tells us that if there is an increase in the use of resources, either monetary or physical, in the direction of some uses, there has to be a reduction in other uses.”
This economic truth plays out in several ways when it comes to corporate tax incentives, Cordato explains. “Corporate subsidy programs to attract some businesses unfairly crowd out the business and economic activities of others,” he said. “And this occurs regardless of the form that the subsidies take, whether through direct payments or various kinds of tax breaks.”
One way in which incentives lead to “crowding out” involves state government revenues, Cordato said. “Assuming that the overall size of the state budget remains the same, taxes for existing businesses, consumers, and income earners generally will have to be higher to make up for direct incentive payments or lost revenue,” he said. “The N.C. Department of Revenue says well over $400 million was allocated in corporate incentives for 2014. This money has to come out of the pockets of North Carolinians generally.”
“Activity throughout the economy — spending, investing, and entrepreneurship — is curtailed,” Cordato added. “That puts a dent in economic growth. There is a coercive wealth transfer from existing taxpayers to all business entities that received incentives.”
Incentive supporters never account for the wealth transfer, Cordato said. “They never make the case that subsidized economic ventures are more valuable to the state’s economy, and therefore to the state’s coffers, than the spending, investment, and entrepreneurship that would have occurred if that money had never been transferred.”
Another form of “crowding out” involves access to resources such as labor, land, and building supplies, Cordato said. “Added demand for these resources that results from state-funded special privileges to some and not to others drives up their prices,” he said. “That means higher costs for all businesses that are seeking access to these resources.”
“So there is a wealth transfer to the favored business not only from taxpayers generally but especially from existing businesses that will reduce their investments because of higher costs,” Cordato added. “Subsidized businesses crowd out, to some degree, existing businesses in the competition for resources. This is why incentive programs implicitly pick both winners and losers.”
Cordato disagrees with policymakers who lament Volvo’s recent decision not to locate a new plant in North Carolina. “When the state ‘loses’ a bid for a company to which it is making a large subsidy offer, it is actually a win for home-based and homegrown companies that will have greater and lower-cost access to resources.”
Those who believe otherwise are effectively supporting “state-based central planning,” Cordato said. “Economic incentives are an attempt by politicians to direct resources that are not their own to investments that they believe will be better for the economy than those that would be chosen if the actual resource owners were left to their own judgments.”
Politicians and bureaucrats end up making “economically arbitrary decisions,” Cordato said. “They transfer control over resource use from the more efficient setting of private-sector resource owners and entrepreneurs to the less efficient public sector,” he said. “This is why incentives-based economic policies are harmful to economic growth.”