Recently, I’ve written about how financial incentives that states provide to businesses in the form of tax breaks and subsidies ��Dz�’t increase economic activity, have fiscal costs, are ineffective in steering the economy, and lack taxpayer protections when the firms that get money ��Dz�’t meet their promises. In my final post in this series, I’ll elaborate on how states and localities use incentives in an attempt to spur economic growth using two specific examples: financial incentives for sports venues and financial incentives for film production.

Financial Incentives for Sports Venues

State and local governments sometimes use taxpayer dollars to fund professional and amateur sports venues. Stadiums such as Marlins Park in Miami, Florida, and AT&T Stadium in Arlington, Texas, were developed in part with public funding. In Arkansas, was built using $50 million in voter-approved bonds. The state also spends $849,500 annually to manage .

Supporters say it makes sense to use public money to build sports venues because they establish civic pride, increase tax collections, and spur secondary investment and indirect jobs. However, real-world evidence suggests that sports venues do little to boost economic activity. Temple University economist Michael Leeds says that “a has about the same impact on a community as a midsize department store.” Further, Harvard economist Greg Mankiw analyzed various polls of the economics profession and found that 85 percent of economists agree that .

Why Stadiums May Not Help Local Economies

Sports franchises generally do not generate new spending because households have a limited budget for entertainment. Think about it: if you want to attend a Cowboys game while you’re on vacation in Dallas, the money you’ll spend on those tickets is money you can’t spend on something else, like a visit to Six Flags over Texas. Sports venues ��Dz�’t really create new spending; they just shift it from one entertainment venue to another—robbing Peter to pay Paul.

Additionally, the congestion caused by sporting events can drive people who are not attending the event away from the area. This deterrent effect has a negative economic impact: the money these people would have spent at area restaurants, shops, and other businesses gets redirected. For example, a 2003 report from the Los Angeles city controller found that after the Lakers and Kings left the small city of Inglewood, California, to move 11 miles to the Staples Center in downtown Los Angeles, Inglewood actually experienced increases in economic activity. Now, if you ask any Angeleno if they’ve tried to go to another event downtown at the same time as a basketball or hockey game, they’ll probably tell you they spent so long sitting in traffic just trying to get to a parking lot in time to catch their show that they were almost late and had to skip their plans to enjoy dinner at a nearby restaurant. Some local businesses might see increased activity on game days, but there are trade-offs; business doesn’t simply increase.

Tax Incentives for Filmmaking: Do They Work?

Film and motion picture incentives are other specialty incentives that have become more popular over the last decade. As of 2014, nearly 40 states offered motion picture incentives, according to the . Arkansas belongs to this category, offering a rebate on all qualified production, with an additional rebate on the payroll of employees who are full-time Arkansas residents. These rebates reduce a firm’s costs by repaying a portion of what it has already spent.

Proponents of film incentives argue that these specialty rebates and tax breaks boost the economy because production crews must stay in local hotels and eat in local restaurants. Advocates also argue that producing films in a particular state increases tourism because movie buffs want to see where films are made. That may be true in California, since Los Angeles has a longstanding reputation as the setting for countless famous movies and TV shows. However, evidence from other states shows that the return on motion picture incentives is very low. Even in California, film tax credits only recoup 65 cents for every dollar spent, according to the Times.

States Lose Money on Tax Incentives for Film Production

Consider the cases of Massachusetts and Louisiana. for every dollar it issued in tax credits from 2006 through 2012, a loss of 87 percent. And of $171.4 million on the state budget in 2014 alone. The negative fiscal impacts indicate that not only do film incentives not bring a return on investment, they do not even pay for themselves. States must increase taxes to pay for them or cut spending elsewhere. Either way, film incentives are hurting taxpayers.

Evidence shows that the primary beneficiaries of film incentives are out-of-state companies and individuals. In written testimony to the finance committee of the Alaska House of Representatives, testified that while some benefits go to in-state filmmakers and suppliers, film tax credits mainly just transfer money from in-state taxpayers to out-of-state production companies. For instance, total Massachusetts production spending that was eligible for from 2006 through 2012 was more than $1.64 billion. But only $556.3 million, or 33 percent, was spent on Massachusetts businesses or residents.

Moreover, the jobs created by film production are temporary. Catering companies, extras, local prop builders, and so forth are employed only as long as production lasts. Filmmaking is finite: a movie is not filmed forever. A film being produced along the Mississippi River may provide local jobs for a while, but when production ends, so do the local jobs.

Conclusion

Outcomes in Arkansas and other states show that there is no reason for governments to provide tax incentives and subsidies to build sports venues or attract film producers. These subsidies and tax incentives fail to create the desired outcomes. They also take money from taxpayers that could be better spent in other areas where taxpayer funding has proven effective or that would be better left in taxpayers’ pockets where they can use that money to improve their own lives.

Earlier this month, software engineering firm Elyxor pledged to create 45 new tech jobs in North Little Rock over the next five years. Arkansas Online quoted Governor Asa Hutchinson as saying, “While we have a diversified economy in Arkansas … we will not be complete as a state and complete as an economy until we have a dynamic, sustained technology sector in this state.” As I explained in my first post in this series, Elyxor will receive an income tax credit for 1 percent of its total payroll in exchange for hiring these employees. This situation is a prime example of the government trying to steer the economy to help with economic development.

One reason why many politicians and taxpayers support such financial incentives for businesses is that they think governments can influence specific economic activities by designing and issuing incentives that address perceived needs such as job creation, project investment, or research and development. Governments are also supposedly able to influence industry composition, or the types of businesses in the state, by offering targeted business incentives.

Steering the economy doesn’t work, though, and can actually be harmful for two reasons: regional unrealism and resource allocation. Let me explain what I mean by those terms.

Specializing in Comparative Advantages Helps Regions Prosper

Regions prosper when they specialize in the industries where they have a , meaning they produce a good or service more efficiently than other regions do. For example, Arkansas has a comparative advantage in rice farming. The state’s water resources and topography allow Arkansas farmers to grow rice more efficiently than farmers in other states. This comparative advantage has led Arkansas to .

Specialization in comparative advantages often leads to industry clusters. When these clusters occur naturally, they can further boost economic productivity. The economic benefits of natural clusters, such as those for computer and software development firms in Silicon Valley, have led economic developers to attempt to create artificial clusters. Arkansas’s targeted business incentives, which are designed to attract companies that specialize in transportation logistics, information technology, life sciences, bio-based products, agriculture, and advanced materials and manufacturing systems, are one example.

Incentives, however, are not necessary to attract firms that align with a region’s natural comparative advantages. The��comparative advantage alone, whether it is the workforce, technology, or location, is reason enough for firms in��that industry to locate in the region. If Arkansas had a comparative advantage in “knowledge-based” industries, such as software development, knowledge-based firms would locate in Arkansas regardless of the incentives the state provided. We see this natural clustering without government incentives in California, where Brook Taylor, spokesman for the Governor’s Office of Business and Economic Development, said that “are being built in spite of the fact that we ��Dz�’t have specific tax credits or incentives for them. Companies are just building them here because it makes sense.”

Regional Unrealism Hurts Arkansas’s Economy

Steering the Arkansas economy into industries where it does not have a comparative advantage, however, makes Arkansas worse off. points out that Arkansas would actually��“make itself poorer if it tried to specialize in ways that were inconsistent with its comparative advantage.”��Market distortions lead to regional unrealism, which is the accumulation and use of resources in areas and activities��in which they are not best used. When a state does not do what it is good at, but rather what it dreams it could��be good at, its economy does not reach its production potential and the state is poorer as a result.��To see how regional unrealism harms states, consider Arkansas’s comparative advantage in rice production. ��Imagine that Arkansas’s leaders thought that ski resorts were the key to a successful economy. By issuing enough subsidies and tax breaks, Arkansas could turn its rice fields into ski lodges. Rather than Arkansas farmers raising roughly half the nation’s rice, vacationers would be skiing down fake slopes. Would this arrangement make Arkansas wealthier?

Clearly, it would not. The state would waste massive resources and opportunities trying to support a ski industry. The land, labor, and climate of eastern Arkansas is much better suited for growing rice than it is for downhill skiing. Another region that is less efficient at producing rice might make up for the lost production in Arkansas, but since it��is less efficient, rice prices for consumers would rise. Arkansas and its residents are much better off when the state uses its resources to farm rice instead of pretending to be Colorado.

While this is a very clear example of how regional unrealism makes states worse off, it’s not always this obvious. Most times it occurs at levels that are very hard to see. Issuing tax breaks and subsidies to may not seem as absurd as trying to cultivate skiing in Arkansas, but if firms such as Nordex and Hewlett Packard Enterprises are not here because of natural economic conditions, we are making ourselves poorer.

Markets Allocate Resources Better Than Government Intervention Does

Why do people think the government should steer the economy? They may assume that the government is better than the market at allocating resources. However, Nobel Prize-winning economist pointed out that no single person or entity knows all the relevant information about the entire economy that is required to make optimal decisions. There is no omniscient wizard who knows exactly which widgets need to be made, how many need to be made, where they need to be sold, and at what price. Rather, people have specific, tacit knowledge about a business or industry, and the potential to earn a profit motivates them to react to market signals, such as prices. Governments, on the other hand, do not have the same profit incentive and are too far removed from market signals to behave in the same way. Individuals reacting to market signals lead the economy to focus on its comparative advantages better than government manipulation does.

Conclusion

The idea that governments can steer economies into sustained economic growth is a myth. History has repeatedly shown this. Government manipulation, although often well intentioned, ends up hurting more than it helps. By limiting government intervention, politicians not only allow entrepreneurs and businesses to make the best economic decisions for their firms, but they also clear the path for states to specialize in their comparative advantages. The outcome is more prosperity for individuals and states alike.

Proponents of financial incentives for business argue that tax breaks and subsidies ��Dz�’t create costs to the state’s budget. Advocates reason that if Arkansas forgoes taxing a firm in some way, and that firm truly would not have located in the state without the tax break, there is no cost to the state. Arkansas does not forgo any tax revenue by issuing the tax break because taxing the firm would have led it to locate elsewhere, which means Arkansas would not receive tax revenue, anyway. If, however, the firm or its employees are not completely exempt and do pay at least some taxes, Arkansas would actually see a tax revenue increase despite the tax break—not to mention that the state would also see the other benefits associated with bringing in more business. In short, proponents say tax breaks may make the state better off.

This argument, though, hinges on the assumption that financial incentives are the deciding factor in where a firm chooses to locate. In Arkansas, officials assume that the jobs created in state-involved economic development projects would not have been created without state intervention. State leaders thus assume that these projects lead to net fiscal gains. But are these fair assumptions?

Are Tax Incentives Really the Deciding Factor in Where Firms Locate?

Anecdotal evidence suggests that incentives are frequently not the deciding factor in where firms locate. In a 2016 analysis, Brian Fanney of the revealed that some companies receiving state aid would have expanded regardless of whether they received incentives. Here are two examples:

Bad Boy Mowers of Batesville would have expanded in Arkansas even without the nearly $4 million it received from the state from 2012 through 2014, according to Scott Lancaster, general counsel for the company.

The state provided Peco Foods of Independence County with $485,000 worth of incentives, but chief operating officer Benny Bishop said, “We would have chosen Arkansas for expansion even without state incentives.”

Issuing tax breaks and subsidies to firms that are going to expand or locate in Arkansas regardless of aid means that the state forgoes tax revenue that it would have otherwise received or sacrifices other, potentially more productive uses of its tax dollars. When incentives are not the deciding factor in where a firm chooses to locate or expand, they are nothing more than a giveaway to politically favored firms—a poor use of tax dollars. What’s more, Arkansas officials take false credit for creating jobs that would have been created anyway. Peco Foods and Bad Boy Mowers are just two examples. But how many other firms have we given aid to that didn’t really need it?

Problems with Letting Businesses Buy and Sell Tax Incentives

States also create costs to their budgets when they allow firms that receive incentives to sell their incentives to other companies in the secondary market. The Arkansas Economic Development Commission allows Arkansas companies to sell certain income tax credits, such as the , the , and the . Let me explain why companies would want to sell or buy a tax incentive and how doing so costs states and taxpayers money.

Consider this hypothetical scenario:

Company A receives $100,000 from the In-House Research by Targeted Business Income Tax Credit to aid in oncology research. However, Company A fails to turn a profit because it has yet to have a breakthrough and develop a medicine to sell. Company A cannot use the $100,000 income tax credit because it does not owe any income taxes. But Company A knows it can sell the tax credit.

Company A sells the credit for $80,000 to Business B, which does owe Arkansas income taxes. When filing taxes, Business B uses the tax credit to reduce its income tax liability by $100,000. Company A is $80,000 better off because it was able to sell its useless incentive to Business B for $80,000. By buying Company A’s tax credit for $80,000, Business B lowered its tax burden by $100,000, so it is $20,000 better off.

The state of Arkansas is the big loser. By allowing Company A to sell its income tax credit to Business B, Arkansas lost $100,000 of tax revenue that it otherwise would have received. In other words, the sale of this tax credit cost the state money, making Arkansas residents worse off.

Furthermore, allowing the sale of incentives to third-party businesses means that the state is effectively subsidizing more than just the company it intended to aid. In our hypothetical scenario, Business B benefited from the state trying to aid Company A, even though the state had no intention of aiding Business B. Business B may or may not belong to the industry the incentives were designed to target. In Arkansas, the�� (AEDC) decides who can and cannot buy tax credits on the secondary market.

The best solution for Arkansas is to eliminate tax credits altogether. But if abolishing tax credits cannot be accomplished, Arkansas should, at the very least, eliminate the ability to sell tax credits. To achieve this, the state should allow these credits to expire unused if the firm remains unprofitable or, as the least desirable option, turn these transferable credits into refundable credits. Refundable credits mean that if the company cannot use the tax credits, the state will trade the credits for cash. In our hypothetical scenario, this means that Company A would still receive $100,000 even if it had no taxable profits to offset. Company B would no longer be involved in any transactions. Although it is not necessarily desirable for the state to award an unprofitable business cash, refundable credits would at least prevent the government from unintentionally subsidizing companies that it had no intention of subsidizing in the first place.

How Financial Incentives for Businesses Hurt Taxpayers

The costs of financial incentives to Arkansas’s budget also likely lead to other negative outcomes. By nature, subsidies shift public money away from public goods, which creates one of two results:

1. Without increasing tax revenue, the city, county, or state issuing the subsidy must decrease the amount of public goods in its jurisdiction. Likely outcomes include a drop in the quality or quantity of infrastructure, a less developed workforce due to reductions in education, and a decrease in the quality or quantity of public goods like roads, education, parks, and bike paths that improve quality of life.

2. The government, wishing to maintain the current level of public goods, raises taxes. Higher taxes are problematic not only for the taxpayers that must pay them but for the broader economy. shows that states with lower taxes enjoy faster economic and employment growth than high-tax states.

Targeted tax breaks have a similar effect. Tax incentives likely lead to increases in marginal tax rates for business that do not receive tax incentives. When the government provides tax incentives to certain companies, it narrows the tax base and lowers the state’s revenue. To make up for the lost revenue, all other taxpayers must pay more. Otherwise, the government must spend less on public goods.

Either scenario—reduced public goods or increased taxes—discourages firms from locating in the region. Firms become less attracted to a region as infrastructure congestion increases and the quality of both the infrastructure and the workforce diminishes. Higher taxes and costs of doing business discourage firms, too.

Conclusion

If you’ve been following this series of blog posts, you now know how tax breaks and subsidies are supposed to help local economies grow, why these financial incentives ��Dz�’t help the economy like politicians say they do, and how tax breaks and subsidies for businesses affect government revenue and spending on public goods. In my next post, you’ll learn about how governments use financial incentives to try to steer the economy.

If you’ve ever wondered why corporate welfare gets such a bad rap, you’ll want to read this post and the five follow-up posts I’ll be publishing over the next few weeks. My goal is to help you understand why governments give tax breaks and subsidies to local businesses and why, even with the best of intentions, these efforts tend to fail and cause new problems. These posts are based on a paper I just published, “Tax Breaks and Subsidies: Challenging the Arkansas Status Quo.”

Economic development is a constant focus of state and local governments. Government officials work to attract businesses, jobs, and investment to the area. They often do this by offering financial incentives, such as tax breaks and subsidies, to select firms. However, financial incentives used to entice businesses come at the taxpayers’ expense. Politicians may enjoy bragging about the remarkable progress they’ve made when they trade tax dollars for a handful of jobs, but they ignore the resulting economic costs. Tax incentives create market distortions that make residents worse off and leave them with less money in their pockets.

Here at ACRE, we want Arkansans to be as well off as possible. To ensure that they are, we want to help you understand the problems with financial incentives, why you should care, and what government officials should do instead to create the best outcomes for each individual Arkansan, their families, and the state as a whole.

What Are Tax Incentives and Subsidies?

When trying to improve economic development, politicians and government officials frequently use two carrots to entice firms: tax incentives and subsidies. Tax incentives aim to attract more business to the state by making it less expensive for businesses to operate in Arkansas relative to other states. Subsidies are grants, or sums of money, that governments give firms in an effort to boost business. Let’s take a look at how each one works.

Tax incentives are always designed to increase a firm’s profitability by decreasing its overall tax burden. They come in several forms:

–Tax exemptions fully excuse firms from paying certain liabilities.

–Tax reductions partially offset the amount a firm is obligated to pay in taxes.

–Tax refunds and rebates repay a portion of the taxes a firm has already paid.

–Tax credits are more flexible: they allow a firm to offset a portion of its tax obligation, and they can often be carried forward to subsequent tax years or be sold in the secondary market.

To see how tax credits can impact a company’s profitability, take a look at this sample profit and loss statement. The yellow highlights show how a business income tax credit, in this case for labor, increases a firm’s bottom line.

How Do Businesses Get Tax Incentives?

To receive tax incentives, firms must meet certain requirements from the government. These vary depending on the tax incentive, but common ones include:

-belonging to certain industries

-investing so much in a particular project

-creating a particular number of jobs

-reaching a minimum payroll threshold

The qualifications often depend on the tax incentive’s purpose, which might be creating new jobs, spurring private investment, or increasing research and development. After all, government officials use incentives to promote their particular agendas. Politicians can attempt to steer business practices with incentives because incentives encourage firms to engage in a specific activity by lowering the firm’s cost of that activity, making the return on investment more attractive.

For example, the Arkansas job creation tax incentive known as is an income tax credit given to qualifying firms based on the payroll of new, full-time, permanent employees. Because the tax credit lowers the firm’s labor costs, the return on investment of hiring a new employee is greater and thus a more attractive option relative to other investments the firm could make. Most recently, , a software engineering, development, and deployment firm, is poised to benefit from Advantage Arkansas. Elyxor will receive an income tax credit for 1 percent of its total payroll. In return, the company plans to hire 45 employees within 5 years.

Using Tax Incentives to Target Preferred Businesses and Industries

Politicians commonly use tax incentives to target certain preferred businesses or industries in which they want to encourage the creation, expansion, or relocation of firms. This targeting is an attempt to steer the economy by lowering the cost of doing business in a desired industry. For example, to six emerging technology sectors:

-advanced materials and manufacturing systems

-agriculture, food, and environmental sciences

-bio-based products (adhesives, biodiesel, ethanol, etc.)

-biotechnology, bioengineering, and life sciences (genetics, geriatrics, oncology)

-information technology

-transportation logistics

Tax incentives aren’t the only tool governments and politicians can use to attract business: they can also use subsidies.

How Governments Use Subsidies to Attract Business

Often, governments issue subsidies under the premise that firms will create jobs or increase investment in the local economy. Subsidies, much like tax incentives, lower the cost of doing business and increase returns on investment. The potential for new jobs and investments to improve economic development makes subsidies an attractive tool for politicians.

Arkansas frequently provides subsidies through the . Both the governor and the legislative council must approve the Arkansas Economic Development Commission’s use of the QACF. The QACF is funded with general revenues, which are funds that come primarily from individual income taxes and sales and use taxes. The legislature allocates these funds across the state’s agencies and programs, including to the QACF. [Related: Making Cents of $18 Million: Voters Decide Whether to Increase Sales Taxes in Pulaski County.]

From its creation in 2007 through end of fiscal year 2015, the QACF has subsidized 73 entities. Some of the largest beneficiaries include Hewlett-Packard in Conway ($10 million), LM Windpower in Little Rock ($6.8 million), and Nordex in Jonesboro ($3.8 million).

Arkansas’s government also provides subsidies through . Amendment 82 of the Arkansas Constitution allows the Arkansas General Assembly to authorize the issuance of general obligation bonds of up to 5 percent of the state’s general revenues collected during the most recent fiscal year (in Arkansas, the fiscal year runs from July 1 to June 30; fiscal year 2016 started on July 1, 2015, and ended June 30, 2016). Amendment 82 bonds are generally reserved for “major economic development projects,” such as the . For a company to receive Amendment 82 bonds, the general assembly must approve the bonds’ issuance by a vote. Because these bonds are general obligations of the state, they become a liability of the taxpayers. In other words, it’s your tax dollars that must pay off the debt the state legislature voted to place on you. Legislators have to find the money for these bonds somewhere, which means they could cut spending elsewhere or, more likely, raise taxes.

Conclusion

Rather than focusing on developing the next special tax break or subsidy, government officials should focus on creating a better business environment to attract and retain businesses. Specifically, Arkansas should implement comprehensive tax reform that not only lowers taxes for all businesses, but creates a more simple, fair, and transparent system.

Stay tuned for my next post, where I’ll discuss why financial incentives ��Dz�’t have the positive effect on economic activity that their supporters think they do.