The Expensive Folly of Tax Incentives

There is little evidence that giving away the taxpayers’ money for economic development works. Only the market can create jobs.
by | April 23, 2012
 

As the New York Times reported recently, Gov. Chris Christie of New Jersey has approved $1.57 billion in tax incentives to businesses since taking office in 2010. The incentives are touted as a way to grow the state's economy, which lost more than 260,000 jobs during the recession.

Every state has at least one tax-incentive program for economic development, according to a recent report by the Pew Center on the States which concluded that "no state ensures that policy makers rely on good evidence about whether these investments deliver a strong return."

Over roughly the past decade, the number of loan, grant, tax-credit and other incentive programs has doubled, according to the Council for Community and Economic Research. While the total amount of money involved is unknown, Pew reports that, for tax incentives alone, state governments spend more than $9 billion annually.

So how can it be that states (and local governments) are spending billions of dollars — and increasing that spending at a rapid clip — without evidence that they're actually getting a return on their investment? Only one answer is possible: The people spending the money don't want to know.

Public officials get to announce deals promising to create jobs and do it with off-balance-sheet obligations of tax revenues that extend for years after those officials have left office. If a deal crashes and burns, no one may notice, and in any case it's years in the future. Why take a chance of derailing things by assembling the evidence and finding that it doesn't work?

In describing their work, the researchers at Pew wrote that "states were assessed on how well they evaluate their incentives, not on the merits or effectiveness of the incentives themselves." Delicately put. But evidence of the success of these programs is scant, and examples of their failure are everywhere. And it makes sense that they would not work. It is illogical to think that states would be better at these economic decisions than the market.

Often one of the tests for granting the incentive is to determine that, absent the incentive, the market would not support the investment. But if the market won't sustain the business being propped up by the subsidies, then that business cannot be contributing to the growth of the economy. A good example is cited in the Times article: "New Jersey provided $261.4 million in tax incentives for the Revel casino in Atlantic City, where the gambling industry's revenues have fallen sharply. And it plans to give a total of $650 million in public financing for a twice-failed entertainment and retail project in the Meadowlands."

Why would government do a better job of investing capital than the market? In fact, the use of incentives often distorts the market and can actually make things worse, as it did in Newark, where, after the state gave Prudential $250 million in tax credits to build a new office tower and move out of its current leased space office, vacancies shot up. That drove down rents and the value of existing investments.

Markets create jobs. The role of government is to create conditions that allow markets to work better. A business-friendly government is one that combines a broad-based, low-rate tax system with a clean, competent and consistent regulatory environment and investments in education and infrastructure.

Yet the "economic-development industry" chugs on. Why? Because it allows public officials to borrow tax dollars from the future and give them to potential campaign donors today. This is legal. And it is widespread. It is the modern version of the spoils system.

Mark Funkhouser  |  Director, GOVERNING Institute
mfunkhouser@governing.com

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