Inefficiency in Economic Development: Money Looking for Makers

Readers of Philip Marcelo’s article, in today’s Providence Journal, about restoration of the historic-structure tax credit program in Rhode Island should see some warning signs indicative of a broader flaw in government economic development:

… the national recession and a 2008 moratorium on the tax-credit program brought such projects to a near halt.

Dozens stalled or never got off the ground, leaving around $150 million in credits –– which can be redeemed to offset business and personal income taxes — still pending final approval. …

Millions of dollars more in credits also could become available, if developers do not meet a May 2013 deadline to show some progress on their projects. (A project must be fully completed and its expenses reviewed before state officials approve issuing credits.)

Plainly put, this is money in search of a productive use in the nation’s most-stalled state-level economy.  Politicians tend to present these programs in terms of their projected output, and policy people who object tend to respond by suggesting that the private-sector could achieve greater output if it were permitted to use the same amount of money without government micromanagement.  The problem is that this discussion leaves the average person unable to connect the economic dots — perhaps because insufficiently interested.

The first thing to recognize is that the money allocated for these programs has real budgetary effects, even though it hasn’t been spent yet. The state must plan a reduction in the amount of taxes that it expects to take in because it is promising credits.  That reduction must ultimately come out of other programs or be supplanted with higher taxes on somebody else.

And as we learned when 38 Studios was seeking tax credits in a last-chance effort to raise some money, not all of the cash goes to the company doing the productive activity that the state wants to see.  Marcelo writes that state and federal tax credits for renovation of historic buildings amount to “essentially half of a developer’s costs would be covered,” but that money comes through taxes.  The developer would both have to have a tax liability equal to at least half of the cost of the project and be able to front the money for materials and labor.

In some cases, suppliers will extend zero-interest credit to builders, and some subcontractors might be willing weight their payments toward the end of the project, but the likelihood is that lending costs will siphon off some of the funds.

It is much simpler for a developer to sell the free-money from the government to a tax credit broker for less than it’s actually worth.  A Boston Globe article about film studio tax credits suggests that the typical studio only actually receives 87% of the total credit amount, with a broker taking 3% and those who buy the credits using the other 10% to offset their own taxes.

A concrete example of what the private sector could do with the money that flows into the financial sector through this route came up at an ash-scattering ceremony for a deceased young carpenter with whom I worked.  In the parking lot of the Eisenhower House at Fort Adams Park in Newport, another of the carpenters in attendance mentioned that work on Aquidneck Island continues to be harder and harder to come by and that a typical three-quarter-ton work van is not eligible for the resident discount on tolls paid by E-Z Pass because it is over the weight limit.

That means that carpenters who must cross the Newport Bridge every day for work face an instant $1 per hour cut in their take-home pay.  The looming toll on the Sakonnet River Bridge would likely have the same effect.  (Imagine a Tiverton carpenter working in Jamestown, thus crossing two tolled bridges, which I’ve done from time to time.)

For such workers, the convenience of E-Z Pass comes with a significant cost.  Apart from the $20.95 spent on the transponder itself, they must come up with six weeks of toll money in advance.  That’s $240 that the state gets to hold on to and the worker can’t use to live on or to pay down debt.

The financial difficulties that these policy traps create for carpenters such as my friend are difficult to quantify on a large scale, but the large scale is critical to consider.  How much does this ultimately cost the economy?  Either contractors must accept the cut in their take-home pay, or they must pass on the cost to customers, perhaps losing jobs to competitors who can bid lower.  In either case, the economic effects ripple outward, as people have less money to give to other productive Rhode Islanders for their goods and services, as well as to donate to charity.

Whatever the mysterious calculation that leads Senate President Teresa Paiva-Weed (D, Newport) to assert that a $27 million tax credit “could generate $75 million to $100 million in construction work,” the public can be confident that it does not take into account the economic costs of other government policies that could otherwise be changed.  And the primary beneficiaries appear to be the brokers who make their fortunes managing the flow of money out of government and the politicians who use good-sounding programs to distract from the real culprits in Rhode Island’s suffering private sector, namely its overall taxing, spending, and regulating culture.