EKIP– Expert Club for Economics and Politics A Different Opinion
There is a widespread misconception that tax breaks for industry are no different from subsidizing it. Unfortunately, like many other economic myths, this one just won't die.
The video game industry is one recent example. For years, critics have argued that game developers are given an unfair advantage and “subsidies” through a range of state and federal tax breaks that lower the cost of design and artificially boost production.
The most frequently cited source of this criticism is a New York Times article that criticized developers for receiving such tax breaks. And while the lack of economic logic is not unusual for the NYT, even some free-market advocates have fallen for it. Given this confusion, it’s worth taking a closer look at the nature of these ideas.
Tax breaks are not subsidies
Decades ago, economists like Mises and Rothbard argued that tax breaks are neither economically nor ethically equivalent to receiving subsidies. Simply put, being allowed to keep your income is not the same as taking it from your competitors. Breaks and legal loopholes do not forcibly redistribute wealth, unlike taxes and subsidies, which support some producers at the expense of others.
Yes, entrepreneurs who benefit from tax breaks will incur fewer costs than entrepreneurs who do not. But this does not mean that the breaks or loopholes provide an unfair advantage; in fact, the opposite is true – it shows that taxes punish entrepreneurs who are unfortunately obligated to pay them.
Tax breaks are beneficial to those who claim them, but they are not subsidies. Rather, the breaks and loopholes are life jackets in a sea of redistribution of wealth. Mises put it well: “ capitalism breathes through these loopholes.” Unfortunately, most analysts continue to miss his clear insight.
For example, the NYT claims that Electronic Arts (EA) receives “financial support from U.S. taxpayers to reduce its tax liability.” But EA receives nothing from other taxpayers by reducing its own tax liability. Tax breaks are not levies, unless we consider “taxpayers” to be entitled to the income generated by the industry.
Government is not a source of wealth
Similar arguments are usually given for the government:
"Over the past five years [2006-2011], Electronic Arts has siphoned off tens of millions in tax credits for research and development for its diverse range of games, according to the company's regular reports. (Company officials declined to say how much of that money came from the federal government.)"
This sounds like EA used someone else's money to fund its own projects, but, again, the company simply paid less in taxes than it would have otherwise. Unless the government is the source of the wealth or has previously had a claim to it (but of course the state has not claimed to own it), there is no reason to think that tax exemptions are tantamount to subsidizing private enterprises with funds from the state treasury.
Unfortunately, many people see the government as a neutral arbiter in handing out aid to those in need. In this context, critics argue that the debate is not about whether the legal loopholes are technically subsidies, or whether subsidies are even economically efficient. The problem, they argue, is that the games industry is claiming relief it doesn't deserve.
The tax breaks date back to the 1950s and 1980s and were originally intended to boost U.S. competitiveness—first against the Soviet Union and later against Japan. [1] The breaks were primarily for new technologies, but were eventually expanded to include software development and other types of research used in improving games. However, analysts say the games themselves are not innovative enough to warrant the tax breaks:
"Michael D. Rashkin, author of "A Practical Guide to Research and Development Tax Incentives," says the video game industry has failed to make a technological breakthrough that benefits anyone other than shareholders, employees, and customers." [!]
Who else could they help? Rashkin's claim is extremely controversial when we consider that according to estimates, the number of players worldwide is more than one billion people. Isn't the fact that the video game industry creates value for so many people enough?
Obviously, this is not the expected innovation: it has to be the kind of innovation that will appeal to critics. For example:
“The research credit is helping the wrong companies and encouraging the wrong kind of research,” said Mr. Rashkin, a tax expert and CEO of Marvell Technology, a company based in Santa Clara, California. “By diverting funds from where they would be most effective, the credit is stifling American innovation.”
These condescending jabs at game designers are unfortunately commonplace, and sound almost like some physiocrat who believes that all work other than agriculture—particularly the production of consumer services—is unproductive. Yet the subjective approach to value theory reveals the lack of economic logic in such comparisons between “right” and “wrong” innovation.
Of course, when criticizing government intervention or supporting markets, we must be careful not to also defend the economic status quo. The games industry is supported by economic protections, especially intellectual property law. [2] But that does not justify imposing more taxes on developers; at best, closing loopholes or imposing additional taxes will continue to be used to redistribute wealth in a similar way, mainly in favor of the industry’s biggest competitors.
Ultimately, we need to understand what government intervention is and avoid conflating real problems with alternative solutions (even marginal ones). Only in this way can we be sure that the only “subsidies” received by producers are those that consumers are willing to pay voluntarily.
Translation: Ivelina Petrova
Editorial: Daniel Vassilev
The original text in English can be found here.
[1] It should be noted that the productivity in the Soviet Union ultimately turned out to be a socialist mirage, while Japan's economic growth was largely the result of a massive credit boom, which was inevitably followed by an economic downturn.
[2] Some protections vary from state to state. In addition to tax breaks, the state of Texas also reimburses developers for any excess tax liability they may have incurred. Additionally, while the U.S. and UK policies focus on tax breaks, the Canadian government directly subsidizes the opening of new studios in Montreal and Toronto, although it is unclear to what extent tax breaks are also included in these deals.
