Getting Tricked By the Wrong Kind of Incentives
When state lawmakers authorize new programs that spend public money on selective business subsidies, they often call them “incentives.” The programs provide companies with extra cash as an incentive to come to Michigan or expand their business within the state. In general, selective subsidies don’t work. They are expensive, unfair to the businesses that don’t get taxpayer money, and ineffective at creating jobs. Giving them is also an odd twist to a concept that ought to inform policymaking. Lawmakers ought to care about the economic incentives of the broad economic environment more than spending money on subsidies called “incentives.”
Lawmakers can try to influence behavior by spending money, but their laws also change people’s economic incentives. For instance, they use tax policy to manipulate their decisions. They don’t want people to smoke, so they levy high taxes on cigarettes. They also keep incentives in mind when they consider what income tax rates to impose. Income taxes discourage work, but they are not meant to be punitive as much as an attempt to raise revenue. Lawmakers ought to limit the economic harms of taxes by lowering rates when they can afford to do so, and it creates an incentive to earn more.
There are lots of other ways that lawmakers can create better economic incentives through policy. If lawmakers want people to have an incentive to work, they should, for example, require occupational licenses only when they are needed to protect health and safety. Making it necessary for someone to go through lengthy and expensive training before being legally allowed to work keeps people from gainful employment.
Michigan’s energy regulatory system provides monopoly profits to incumbent utilities when a competitive market could provide cheaper and more reliable energy, and this is a disincentive to both working and living in Michigan. A number of manufacturers have complained about the costs of electricity in the state, after all.
These are a few of the incentives that matter to the state’s economic prospects. Paying a handful of companies with taxpayer cash, on the other hand, does not. The academic evidence makes that clear.
There is another lesson about incentives, too. People ought to notice that some policy arguments are self-serving. Bridge builders have an incentive to sell more bridges, and their arguments for them may mask underlying motives.
James Madison noted this in Federalist 10, saying that the connection between our reason and our self-love drives us to feel like the things that benefit us actually benefit the public as a whole. He even raises an issue similar to the one inherent in select business subsidies. “Shall domestic manufacturers be encouraged, and by what degree, by restrictions on foreign manufactures?” He says that the question would be “differently decided by the landed and the manufacturing classes, and probably by neither with a sole regard to justice and the public good.”
In short, our economic self-interests blind us to the essential question of policymaking in a democratic republic: Does this policy serve the common good? Manufacturers want to be protected from competition, and they support protectionism, regardless of the broader costs to society. The people who want more in select business subsidies tend to be the businesses that will get to collect them and the government agencies that hand them out. Each has an economic incentive to support selective business incentives.
That’s not to say that their arguments ought to be disregarded. The people who benefit from this spending may bring an important perspective to the table. If a policy that benefits them also has public benefits, then it ought to be an easy sell.
The people who want the state to offer more “incentives” in the form of special handouts struggle to make a compelling case, however. They can point to companies that said that they wouldn’t come to Michigan without extra taxpayer cash. But that’s not enough. The point of job creation programs is to improve the state’s economy, and that requires testing their promise against the state’s actual economic performance. That’s also where the case for select business subsidies falls apart: They simply cannot provide the economic growth that they are created to generate.
Which is why lawmakers ought to stop mucking around with what they call “incentives” and focus instead on the broader economic factors they can influence through state policy.
James Hohman is the director of fiscal policy at the Mackinac Center for Public Policy, a research and educational institute in Midland, Michigan.
