No place like New York (except Cleveland)

An editorial over the weekend in the Wall Street Journal pointed me towards a topic I hadn't noticed before: state-by-state tax credits for the film industry. New York is considering scrapping its 35% tax credit for films shot in the city to help close the state's budget gap. To which 30 Rock's Alec Baldwin, ever a paragon of verbal restraint, responded: "if these tax breaks are not reinstated into the budget, film production in this town is going to collapse."

My first thought was that New York shouldn't worry about Baldwin's threat, because cities aren't substitutable. If you've got a romantic comedy that revolves around Times Square and Central Park, you can't very well film in Cleveland, can you? But then I went and checked where 30 Rock was filmed, and the one episode that takes place in Cleveland was actually filmed in New York. Egad. If New York can be an appropriate substitute for Cleveland, why can't Cleveland play understudy to New York? Perhaps Baldwin was right.



But it seems awfully strange that the Journal uses this as occasion for bragging. Says the paper: "We're constantly told that taxes don't matter to business and investors, but listen to that noted supply-side economist, Alec Baldwin." (Do you get it? It's funny because Alec Baldwin is an actor, not an economist, and even he knows that "taxes matter." Ha ha ha.) Let's not get carried away.

The Journal is confusing (or at least conflating) two ways in which taxes "matter." The one that the editorial page is usually and obsessively worried about is how taxes affect wealth creation -- how many hours people work, how many workers a firm hires, and so forth. And if you wanted to test that effect in the context of film, the way to do it would be install and tinker with a national tax credit, and then sit back and watch whether the number of films produced went up or down. But tax credits and subsidies that vary by state and vary by industry are something else entirely.

First, they are apt to effect not the total level of wealth creation, but where it takes place. This is neutral at best and bad at worst. States compete for particular industries -- Louis Brandeis famously described this as federalism's "race to the bottom" -- in way that might be beneficial for the winners but isn't always great for the country has a whole. (The Journal wanly acknowledges this at the end of the editorial.) Delaware, for instance, gets more than half of the publicly traded companies in the US to incorporate in the state with a cornucopia of tax inducements and lax regulation. Great for the blue-hen state. Less great for US corporate governance.

Second, the industry-specific tax credits that the Journal is taking pride in are otherwise known as industrial policy: when the government uses the power of law to encourage investment in a particular industry. But surely the Wall Street Journal, of all places, believes that capital markets are more efficient than the government. (I googled "Wall Street Journal Editorial Page" and "industrial policy," and on the first page of results I found the editors whining about it here and here.) But not when industrial policy can be used to make the point that "taxes matter."