Targeted Tax Credits: Enriching Cronies, Crushing the Little Guy

One issue being hotly debated this summer in Raleigh is the issue of film industry tax credits. It seems that  R’s and D’s are fairly united in their support for some sort of political privilege – be it a continuation of the tax credit scheduled to expire, or transforming to a ‘grant’ program – to Hollywood film studios. Disappointingly, the voices are few in the state legislature opposing such corporate welfare and cronyism.

This paper recently produced by George Mason University economists is a must-read for legislators and concerned citizens interested in learning about the true nature of state-provided targeted benefits.

The paper lays out how such targeted benefits not only harm a state’s economic growth due to the misallocation of resources caused by a distortion of market signals, but more importantly creates an environment in which the politically powerful trade favors at the expense of the rest of us, concentrating more power in the hands of the political class and thus eroding the freedom of citizens.

Some snippets from the paper’s summary:

When policymakers provide targeted benefits, they remove the profit and loss signals that investors would otherwise use to determine the highest-valued uses of a particular resource. The lack of market signals also means that policymakers have no way of knowing the value of alternative uses of the resources being redirected as a result of their policies. The result is costly government investments that often fail to yield the benefits expected by policymakers.

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Companies end up expending resources on the political relationships necessary to secure future gains in the form of targeted benefits. These are resources that would otherwise be used for wealth creation. …Companies begin to habitually serve political interests instead of satisfying consumer needs, and political competition replaces market competition. Consequently, cronyism—the established practice of exchanging favors between powerful people in politics and business—may become entrenched in the social fabric of a state.

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Policymakers therefore have an incentive to make large-scale, observable investments that appear to contribute more to a state’s economic development. This creates a bias toward large firms when granting targeted benefits.

Legislators supporting targeted state tax credits and other benefits must explain to citizens why they favor entrenching cronyism and rent seeking over fair competition and more efficient economic and job growth.