An article in today’s New York Times highlights a growing trend in state taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy: giving tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s to the film industry to shoot movies in a given state. Such a phenomenon is a terrific application of countless economic principles to be highlighted by the next Greg Mankiw when writing his/her introductory textbook for freshman economics.
Foremost, it shows that economic actors (like owners of businesses) respond to incentives, whether you say the credits fall under the heading of lower taxes or a government subsidy (essentially the two are equivalent).
It also highlights a prisoner’s dilemma problem that the economy of the nation as a whole faces. Each state government may have an individual incentive to give special subsidies to film makers to lure them into their state. However, these tax credits must be paid for by higher taxes (or lower spending) for others. In the end, if each state passes a film tax credit (which it appears may happen) given that another state has and that it may be in their own self-interest to do so, the national economy has had another tax distortion imposed on it. Overall, film production will be favored at the expense of higher taxes on other activities, leading to too much film production and too little of something else, thereby lowering the nation’s economic well-being. Also, to the extent that film makers are locating for tax reasons, they are not locating based upon where productivity is maximized (output per unit of input).
(Technically, if government spending was cut and the spending that was cut was not valued very highly, a tax reduction only for film could expand economic well-being, but such a case is unlikely.)
This phenomenon is often called a “race to the bottom.” But paradoxically, many on the political left who complain about races to the bottom in tax policy are the same individuals who will argue when a tax cut is proposed that taxes don’t matter and that what matters for business is government services. You can’t really have the extreme of both. And that also goes for those on the political right who ignore the race to the bottom, yet say taxes are very important in decision making. You can’t have both.
The fact of the matter is that government spending and taxes both matter for how economic actors choose their physical locations, and under certain conditions like these handouts to film producers, races to the bottom can occur.
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