After of wave of new and expanded state film tax credits in recent years, Connecticut has become one of the few to buck the film credit arms race and scale back its program. It is a moderate step, as the film credit was not permanently killed but rather merely suspended for two years, and TV productions will still be eligible for tax credits, but it is a start nonetheless. California and other states would be wise to follow—and improve upon—Connecticut's example.
According to a recent Wall Street Journal article, more than 80 movies have benefited to the tune of $137.4 million in tax credits since Connecticut's film and TV credit program was launched in 2006. In fiscal year 2012, the state provided $95.8 million in such tax credits, with $21.9 million going to films and the remaining $73.9 million going to television productions, which have comprised the bulk of the credits over the past few years. A $1.5 billion budget deficit prompted state legislators to reevaluate their priorities, however, and the film credit was one of the casualties.
California, like many other states, has gone in the other direction. Last year the state passed a 2-year, $200 million extension to its film tax credit, which was first implemented in 2009. In a study released earlier this year, I argued that the state's film credit, and a number of other state tax credits, unfairly tilt the playing field in favor of certain politically-connected businesses and industries. When the nationwide impact is considered, such state tax credits are, at best, a zero-sum game: resources are shifted from one state to another, but the credits themselves do not create any net economic growth. At the state level, tax credits can help to "steal" business away from other states, but there is also a corresponding opportunity cost. More capital and other resources are poured into the industries receiving favorable tax treatment, meaning that less resources are available to invest in all the other industries in the state. Moreover, this is, by definition, inefficient, since these resources would have been allocated differently in a truly free market without government intrusion.
It would be better to improve the overall business climate by treating all industries the same, reducing the overall corporate tax rate as much as possible, and letting the forces of supply and demand determine the winners and the losers. Not only would this allow for the greatest amount of prosperity, it would ensure that businesses had the greatest incentives to satisfy the needs of consumers, rather than the desires of politicians.
Using data from the California Franchise Tax Board and the Department of Finance, I estimated that the state could reduce its overall corporate tax rate by at least 20 percent by eliminating tax credits such as the Research and Development Credit, Accelerated Depreciation of Research and Experimental Costs, Double-Weighted Sales Factor (repealed by voters in November 2012), Film Credit, Low-Income Housing Credit, Hiring Credit, Percentage Depletion of Mineral and Other Natural Resources, and Expensing of Timber Growing Costs tax breaks—all without resulting in any net loss in revenue to the state. (Of course, reducing both state spending and taxes would be even better.)
Yet, the siren song of tax credits is tantalizing to politicians from both sides of the political spectrum who think they can "create jobs" (especially within their own districts) or want to reward certain industries for pragmatic or ideological reasons. As I wrote in the California tax credits study,
While targeted tax breaks might seem compelling as a means to attract and retain business in an increasingly competitive global economy, they clearly come with risks. Notwithstanding the fact that even fiscal conservatives may be seduced into supporting them—even based on legitimate desires for economic growth—they should be avoided because their distortionary effects on the state’s economy are harmful. Crony capitalism that benefits a few undermines the free-market capitalism that benefits the many.
Policymakers must be aware that when they implement policies that favor certain businesses or industries—through the tax code, state spending programs, or regulation—they are necessarily harming other industries. Moreover, in doing so, they diminish economic activity by redirecting capital away from the purposes taxpayers and investors prefer toward less efficient ends based on their own preferences. Besides, the “important” industries of today may not be the important industries of tomorrow.
Of course, special-interest politics tends to play a huge role in tax policy. Government is a poor venture capitalist precisely because the incentives and decision-making involved in spending someone else’s money are very different from those involved in spending one’s own money. Failures such as Solyndra are testament to this hubris.
To be clear: tax cuts are much needed in California’s high-tax, high-regulatory business climate and tax rates should be lowered as much as possible, but the rules should be applied evenly, rather than carving out special benefits for some.
Thus, I offered some recommendations to help reduce the tax burden on California taxpayers and increase the fairness of the state's tax code:
- Eliminate special tax treatment wherever possible, particularly in cases where:
a. The tax break’s purpose is not clearly defined;
b. The tax break is not serving its intended purpose or has outlived its intended purpose;
c. The tax break is narrowly tailored to benefit a specific industry or type of business; or
d. The tax break is clearly an example of the government picking winners or losers for ideological or special-interest reasons.
- Wherever possible, lower broad tax rates down to tax break levels, rather than raise tax break levels up to broad tax rates.
- Require a clear statement of purpose and performance measures for each tax break—including existing tax breaks without a clear statement of purpose or relevant performance measures—in order to facilitate evaluations of the impact of tax breaks on taxpayers and the state budget.
- Establish a sunset commission to periodically evaluate tax breaks and other state regulations.
- Adopt a Base Realignment and Closure (BRAC)-style commission to evaluate existing tax breaks and regulations. Under this system, a commission would evaluate tax credits based on criteria like those in #1 above and recommend eliminating tax breaks that fail to meet those criteria. The recommendations would have to be considered as a whole and voted up or down by the legislature.
See the full California tax credit study here.
Related Research and Commentary:
» "California Must Reform Tax Code to Spur Economic Growth" (with Jon Coupal) – Orange County Register