If few people pay attention to tax incentives that are being bank rolled partially by their tax dollars it is even more important to understand if tax incentives are sound economic policy. Economists have devised several situations where tax incentives can be economical justified.
1. A society may have unemployed resources that could be used more productively through incentives (Buss 4).
2. If society is fully employed, it may be spending too little on investment in relation to current. Underinvestment is likely only if an investment produces significant externalities or if capital markets do poorly when financing viable private investment (Buss 4).
3. Productivity based on tax incentives, as measured by the value of the consumption it creates, exceeds the productivity of all other feasible investments.
In all three cases, for tax incentives to contribute to economic welfare, they must increase future consumption. And, in the first two cases, this objective is accomplished because the tax incentive causes a net increase in total investment (Buss 4).
Serious studies of business tax credits began in the 1950s. At this point, tax credits were evaluated based upon economic growth on a comparative level instead of one based on econometric approach. Empirical research failed to establish a strong relationship, as predicted in economic theory. As late as the mid-1980s, economists continued to report no association between taxes and economic growth or in business location decisions. The economic upheaval during the 1970s and 1980s produced many new state and federal development programs. Tax research began to separate taxes from expenditures and to single out different taxes and incentives. New models began to find a negative relationship between taxes and economic growth (Buss 6). Also during this period, analysts began to look at nontax factors (public services, infrastructures, and amenities) and economic growth, finding that they matter perhaps as much as or more than taxes.
The elimination and reductions to tax incentives made by Governor Snyder were met with opinion and emotion. Advocacy groups produced literature which cited that tax incentives such as the film tax credit added million of dollars to Michigan's economy. There were other advocacy groups who cited that tax incentives cost the state millions and Michigan could not longer afford to pick winners and losers. This should not be surprising. The economic literature on state taxes on the whole offers very little information on how effective tax credits are. Policy makers are quick to promote and create tax incentives due to the political millage they create. Economists caution that tax incentives should only be used in very specific circumstances. A state will most likely continue to offer tax incentives despite what research finds because they have a good political image. Researchers (Buss) offered a protocol list that every tax incentive should meet:
1. Require a cost benefit analysis prior to large investments in specific firms
2. Require periodic audits and evaluation of all programs
3. Require sunset provisions for all economic development legislation terminating programs unless reauthorized by the Legislature. Failing programs should be terminated.
4. Require transparency of financial documents
5. Require legally binding performance contracts panelizing those firms who do not meet goals.
Buss, Terry M. "The Effect of State Tax Incentives on Economic Growth and Firm Location Decisions: An Overview of the Literature." Economic Development Quarterly: 1-17. Print.