Minneapolis Fed on Tax Incentives for Film Companies

September 11, 2006

The September issue of fedgazette from the Federal Reserve Bank of Minneapolis features a lengthy story on the practice of state and local lawmakers handing out tax incentives to lure filmmakers, in which we’re quoted at length.

As we’ve written before, location-based tax incentives—for filmmakers or any other industry—are almost always bad policy. Location-based tax incentives are defended on grounds that they boost employment and spur economic activity. However, that’s an empirical question, which requires careful economic study. The problem with location-based incentives is that they are almost never accompanied by the requisite scientific review.

Because the costs and benefits aren’t estimated and studied—either before or after implementation—tax incentives commonly end up channeling taxpayer dollars directly into the pockets of rent-seeking film companies, generating no corresponding economic benefits on a net basis.

Ultimately, the main beneficiaries are not taxpayers but lawmakers. Every incentive package that attracts a rent-seeking company allows lawmakers to make public announcements taking credit for “new jobs.” Location-based incentives can therefore be thought of as a market transaction between lawmakers and film companies. Lawmakers purchase favorable media coverage for themselves, film companies accept payment for filming in economically unprofitable places, and taxpayers finance the deal. It’s hard to see how that’s good policy.

From the fedgazette piece:

…[J]ust how much film incentives cost and how much is gained remain a mystery in most programs. The Tax Foundation’s Chamberlain noted that there are no studies by economists that determine the financial benefits or costs of film incentives because very few governments track their costs and tax benefits.

It may be a compelling argument from state and local officials about getting more than you had before, Chamberlain said. “But it’s really a wash or loss.” He added, however, that “you’ll never convince [politicians] that it’s not a good idea—the payoff is too big.” Chamberlain said he once heard another economist describe the incentive issue this way: Incentives were not designed to create jobs but to create job announcements. This may be a little harsh, but “the literature speaks with one voice,” Chamberlain said. “At the national level, this does nothing to spur more activity.”

From an economist’s viewpoint, these are terrible policies, Chamberlain said. In the long run, incentives will erode the tax base because they favor certain (often new) businesses over others, and the tax burden falls disproportionately on existing businesses. The notion of incentives as an investment leaves something to be desired as well. To be considered an investment, incentives should return the original capital plus some profit—in other words, after all the adding and subtracting, incentives should lead to higher total tax revenue…

Chamberlain, from the Tax Foundation, acknowledged that states face a classic prisoner’s dilemma. Here, two crime suspects interviewed separately are offered reduced sentences if each rats the other out; if both stay mum, they’ll go free. But because they are separated, neither trusts the other to keep quiet—so each rats on the other in order to secure a lesser sentence, and ultimately both are worse off.

Incentives work the same way, Chamberlain said. If all states eliminated incentives, they would all be better off; films would still get made, and they would go to the most optimal locations, while states could focus scarce tax dollars on traditional public goods rather than on film incentives. But they’re unable to do so because they can’t trust other states to do the same, and doing nothing is even worse, because states lose economic activity to others offering incentives.

Read the full piece here. More on what the Minneapolis Federal Reserve Bank calls the “Economic War Among the States” here.



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