Governments have long used tax breaks, in lieu of direct subsidies, to attract business or real estate developments to a particular locality. This also has been a perennial political issue.
The use of tax increment financing allows government to fund some development, which is then paid off by the increase in real estate taxes due to the higher value of developed property relative to undeveloped, often nearly abandoned tracts.
The real estate taxes don’t flow to local government treasuries, but instead to pay off bonds that financed construction on the tract.
Film and television production is one example of an industry that seems to wax and wane with the attractiveness of state tax rebates.
Economists are unambiguous about such special tax breaks. If there is any upside, they are useful academically, because TIF deals, and the logic behind them, provide good classroom examples of bad economic policy.
The benefits of TIF and other so-called tax incentives don’t all go to property developers. There are jobs that probably would not exist without TIF-subsidized projects. Why isn’t this good?
The answer is that from the point of view of society as a whole, rather than one municipality, TIF involves an error in reasoning that assumes that what is true for an individual, or in this case a group receiving jobs, is necessarily true for a much larger group — say, society as a whole. If you stand up at a basketball game, you can see the action better. Therefore, if everyone stood up, everyone could see better — not!
If TIF or other targeted subsidies increase economic activity and employment in one neighborhood, one city, one county or state, why don’t all such jurisdictions make themselves better off by implementing such measures? The answer is that such subsidies do little to increase the total amount of property development or employment for the nation as a whole. They just move it from one location to another. Offer subsidies in one city and you may pull businesses away from other cities. But if all cities get into the game, there isn’t more overall economic activity.
When businesses choose a site for new development based, even if only in part, on competing incentive packages, this artificial factor reduces underlying business considerations that reflect true values to society of resources and products.
This points to a distinction between “trade creation” and “trade diversion.” When England and Portugal lowered tariffs on each other’s products, British wool flowed south and Portuguese wine north. Resources were used more efficiently in both countries because Portugal had land and other inputs better suited to producing wine while the same applied to wool in Britain. Growing trade was “created.”
However, when the United Kingdom joined the forerunner of the European Union in 1973, it had to slash imports of food from Australia and New Zealand and instead buy dairy products, meat and wheat from fellow EU members. Australia and New Zealand produced these products with lower use of real resources of land, labor and capital. So stifling their production and boosting that of France and other European countries meant the world as a whole produced less food for a given use of resources. Increased U.K. trade with its new partners was “diverted” from existing, more efficient trade.
In a similar way, property and business development motivated by tax incentives diverts these activities from other locales, but does not “create” any net new activity. And because these artificial incentives reduce the importance of true economic factors, total production of goods and services to meet people’s needs actually is less.
That is too bad. For our nation as a whole, we are poorer as a result.