State Taxation of Business Income

May 5 and 6, 2016
Joshua Rauh of Stanford University, Organizer

Justin Marion, University of California Santa Cruz, and Erich Muehlegger, University of California at Davis and NBER

Tax Compliance and Fiscal Externalities: Evidence from U.S. Diesel Taxation

Fiscal externalities across jurisdictions can arise from imperfect tax enforcement and the avoidance behavior of taxpayers. Base shifting to low tax jurisdictions tends to generate positive fiscal externalities, while understating the overall tax liability leads to negative fiscal externalities when the tax base is apportioned across jurisdictions. While much of the literature has focused on base shifting and the resulting "race-to-the-bottom" in tax rates, Marion and Muehlegger examine an empirical setting illustrating how negative fiscal externalities can dominate. Truckers in the United States owe state diesel taxes based on diesel consumption, which is apportioned to states based on the miles driven in each state. The researchers document that an increase in the tax rates of other states negatively impacts own-state taxed sales, suggesting that evasion by understating the number of gallons consumed is the predominant source of externalities, since doing so reduces the tax revenues of all states. The researchers' estimates of the tax reaction function indicate that local tax rates respond negatively to tax rates in other states, which is in contrast to the canonical race-to-the-bottom but is consistent with the sign of the estimated fiscal externalities.

William F. Fox, University of Tennessee, and Zhou Yang, Robert Morris University

Destination Taxation: Road to Economic Success?

Movement towards destination taxation has been the most significant change in recent state corporation income tax (CIT) policy. This paper explores these changes on both economic activity and CIT revenue. Fox and Yang show that some expansions of destination taxation have tended to increase economic activity as well as CIT revenue, although the positive effect diminishes as state size grows. Increasing sales factor weight expands manufacturing production within a state; however, it does not have a significant impact on the service sector. In general, the effects of destination versus origin taxation depend on the specific ways in which they are imposed.

Alexander Ljungqvist, New York University and NBER, and Michael Smolyansky, Federal Reserve Board

To Cut or Not to Cut? On the Impact of Corporate Taxes on Employment and Income (NBER Working Paper No. 20753)

Do corporate tax increases destroy jobs? And do corporate tax cuts boost employment? Answering these questions has proved empirically challenging. Ljungqvist and Smolyansky propose an identification strategy that exploits variation in corporate income tax rates across U.S. states. Comparing contiguous counties straddling state borders over the period 1970 to 2010, they find that increases in corporate tax rates lead to significant reductions in employment and income. The researchers find little evidence that corporate tax cuts boost economic activity, unless implemented during recessions when they lead to significant increases in employment and income. The authors' spatial-discontinuity approach permits a causal interpretation of these findings by both establishing a plausible counterfactual and overcoming biases resulting from the fact that tax changes are often prompted by changes in economic conditions.

Eric C. Ohrn, Grinnell College

Investment and Employment Responses to State Adoption of Federal Accelerated Depreciation Policies

In the 2000s, the U.S. federal government implemented bonus depreciation and significantly increased Section 179 depreciation allowances in an effort to stimulate business investment and employment. When the policies were enacted and enhanced, many states adopted bonus depreciation and increased their state Section 179 allowances. Other states chose to leave their depreciation polices unaltered. Ohrn uses this variation to estimate investment and employment responses to state adoption of the federal policies. The analysis suggests that both state bonus and state 179 allowances significantly enhance state-level investment. However, an increase in either policy significantly decreases the impact of the other. Estimates suggest that state adoption of federal bonus at the 100% rate increases investment by 17.4%. This effect decreases by 4.7% for each $100,000 of state 179 allowance. Conversely, state 179 allowances of $500,000 increase investment by 10.0%. The effect decreases by 0.47% for every 10 percentage point increase in state bonus. Neither policy affects employment. These results are consistent across sub-samples chosen to mitigate selection concerns.

Jason DeBacker, Middle Tennessee State University; Bradley Heim and Justin Ross, Indiana University; and Shanthi Ramnath, Department of the Treasury

The Impact of State Taxes on Pass-Through Businesses: Evidence from the 2012 Kansas Income Tax Reform

This paper examines the impact of a large-scale tax reform that took place in Kansas and, along with other changes, excluded certain forms of business income from individual taxation at the state level. In theory, lowering these firms' marginal tax rates could stimulate investment thereby boosting the overall state economy. On the other hand, business owners could simply relabel other sources of income to receive favorable tax treatment, in which case, the exemption would fail to generate any additional real business activity. DeBacker, Heim, Ramnath, and Ross test these competing theories using a difference-in-difference model where bordering states serve as a control group for Kansas. They find that the Kansas reform had a small, positive effect on the propensity to report income from self-employment, but failed to generate significant changes to the amount of reported income. Furthermore, the researchers find that the reform had little impact on other forms of business income that were also subject to the exemption. Finally, they attempt to disentangle whether the reform led primarily to a recharacterization of existing income or whether the reform induced a real economic response. They find some evidence that the reform led to a recharacterization of wage income to contract labor.

Enrico Moretti, University of California at Berkeley and NBER, and Daniel Wilson, Federal Reserve Bank of San Francisco

The Effect of State Taxes on the Geographical Location of Top Earners: Evidence from Star Scientists (NBER Working Paper No. 21120)

Moretti and Wilson quantify how sensitive migration by star scientists is to changes in personal and business tax differentials across states. The researchers uncover large, stable, and precisely estimated effects of personal and corporate taxes on star scientists' migration patterns. The long run elasticity of mobility relative to taxes is 1.8 for personal income taxes, 1.9 for state corporate income tax and -1.7 for the investment tax credit. While there are many other factors that drive when innovative individual and innovative companies decide to locate, there are enough firms and workers on the margin that state taxes matter.

Brian Baugh and Hoonsuk Park, Ohio State University, and Itzhak Ben-David, Ohio State University and NBER

Can Taxes Shape an Industry? Evidence from the Implementation of the 'Amazon Tax'

Online retailers have maintained a price advantage over brick-and-mortar retailers since they did not collect sales tax. Recently, several states have required that the online retailer Amazon collect sales tax during checkout. Using transaction-level data, Baugh, Ben-David, and Park document that households living in these states reduce Amazon purchases by 8.8% after sales taxes were implemented, implying an elasticity of –1.2. The effect is more pronounced for large purchases, for which the researchers estimate a reduction of 17.1% in purchases and an elasticity of –2.3. Studying competitors in the electronics field, they detect some evidence of substitution of the lost purchases towards competing retailers.

Adele C. Morris, the Brookings Institution; David Bookbinder, Niskanen Center; and Yoram Bauman, Carbon Washington

State-Level Carbon Taxes: Options and Opportunities for Policymakers

Greenhouse gas (GHG) emissions contribute to the risk of climatic disruption and ocean acidification. Pricing emissions, such as through an excise tax, would address the market failure associated with activities that pose risks to the environment. A number of studies have surveyed the design issues of a U.S. carbon tax at the federal level. Morris, Bookbinder, and Bauman review the design challenges of GHG taxes at the state level. The researchers analyze essential elements of a state level carbon tax and how they affect the distributional and other economic outcomes of the policy. The paper also explains how a tax can be structured with EPA regulatory compliance in mind.

David R. Agrawal, University of Kentucky

The Internet as a Tax Haven? The Effect of the Internet on Tax Competition

High Internet penetration puts downward pressure on tax rates as jurisdictions seek to reduce revenue leakage to tax-free sales; but, taxable online sales will put upward pressure on tax rates because the Internet facilitates tax collection. Agrawal finds that an increase in Internet penetration induces large municipalities on the low-state-tax side of state borders to lower their local tax rates by more than municipalities on the high-state-tax side. He then uses panel data on all local sales tax rates in the country and changes in Internet subscription rates to show that the effect of Internet penetration changes is negative.