Tuesday, October 4, 2011

A suitable government intervention

The downtown stretch of Washington Ave. in St. Louis has been named a 'Great Street' by the American Planning Association.  As reported by Tim Bryant in the Post-Dispatch's Building Blocks blog:
Efforts to redo empty Washington Avenue warehouses as lofts didn't get far until Missouri began granting historic preservation tax credits that made such projects financially feasible. The APA said that, as a result, more than $100 million in Washington Avenue investment soon began.
Without getting into whether the amount of credits was correct, or if the recipients were the 'right' ones, it has always struck me that the effort to rehabilitate Washington Ave. is an good example of possibly appropriate government intervention into the marketplace.  I mean appropriate in the narrow sense that economists usually talk about: interventions that address market failures.

By helping to preserve buildings that are historic and/or pleasant looking (at least to most people), the tax credits addressed the underproduction of a public good (nice historical buildings) that would have been underprovided by the free market.  Nonresidents get benefits from the buildings (by looking at them, or just knowing that they're there) but cannot be charged for this consumption.  The tax credits are a substitute for the money that cannot be collected from these nonresident consumers. 

Because the historic tax credits were targeted at a district rather than single buildings, they also helped to spur agglomeration economies.  These arise because the profitability of one rehab project is tied together with the existence of other projects.  That is, a single rehabbed residential building in a run-down area is not as likely to be as financially viable as one in an area where all buildings are being rehabbed.  Tax credits change developers' expectations about the area as a whole, so more projects will be done there.  As a consequence, projects are clustered together (they agglomerate).

Note what is missing from this discussion: the effect of the tax credits on jobs and/or growth.  This is because tax credits are inappropriate for these purposes unless they are addressing market failures.  I don't know the effects of the Washington Ave. development on employment, tax revenues, etc. in the city of St. Louis.  My suspicion is that the effect are pretty close to zero because the increased activity there means decreased activity elsewhere in the city.  But this suspicion makes little difference to the question of whether the tax credits were economically appropriate.