Economic Effects of State Business Taxation

May 5, 2017
James M. Poterba of MIT and Joshua Rauh of Stanford University, Organizers

Evan E. Mast, Stanford University

Race to the Bottom? Local Tax Break Competition and Business Location

Mast analyzes how competition between localities affects tax breaks and business location decisions. Using data on firm-specific property tax exemptions, he begins by documenting that spatial competition substantially increases local tax breaks. To do so, Mast exploits variation in the number of counties near a town, which is correlated with competition but uncorrelated with other observable town characteristics. He then uses this pattern to estimate a model of localities competing for mobile firms by offering tax breaks. In counterfactual exercises, Mast finds that policies that reduce competition between localities, such as restricting which levels of government can offer tax breaks, have very little effect on equilibrium firm locations but may lower total exemptions by up to 30%. These findings suggest that local tax breaks primarily lower the taxes paid by mobile firms and are unlikely to substantially affect the efficiency of firm location.

Clemens Fuest, Ifo Institute for Economic Research; Andreas Peichl, University of Mannheim, ZEW; and Sebastian Siegloch, the University of Mannheim

Do Higher Corporate Taxes Reduce Wages? Micro Evidence from Germany

This paper estimates the incidence of corporate taxes on wages using a 20-year panel of German municipalities. Administrative linked employer-employee data allows estimating heterogeneous firm and worker effects. Fuest, Peichl, and Siegloch set up a general theoretical framework showing that corporate taxes can have a negative effect on wages in various labor market models. Using event study designs and differences-in-differences models, the researchers test the theoretical predictions. Their results indicate that workers in liable firms bear about 47% of the total tax burden. Empirically, the researchers confirm the importance of labor market institutions and profit shifting possibilities for the incidence of corporate taxes on wages.

Lorenz Kueng, Northwestern University and NBER, and Scott R. Baker, Northwestern University

Shopping for Lower Sales Tax Rates

Using comprehensive high-frequency state and local sales tax data, Kueng and Baker find that household spending responds strongly to changes in sales tax rates. Despite their complexity, such as the the fact that sales taxes are not observed in posted prices and have a wide range of rates and exemptions, households increase online and cross-border shopping and stock up on storable goods before taxes increase. Interestingly, households adjust spending similarly on both taxable and tax-exempt goods. The researchers demonstrate that this seemingly irrational behavior is optimal in the presence of shopping complementarities and provide independent evidence in favor of this new mechanism. While the results demonstrate that salience of sales tax changes is high on average, the researchers also show that upcoming tax changes that are more salient prompt larger responses.

Julian Atanassov, the University of Nebraska, and Xiaoding Liu, the University of Oregon

Taxes, Pledgeable Income and Innovation

Atanassov and Liu hypothesize that corporate income taxes distort firms' incentives to innovate by reducing their pledgeable income. Using a differences-in-differences methodology, the researchers empirically document that large state income tax increases (decreases) stifle (stimulate) corporate innovation over the 1988-2006 period. Exploring the mechanisms, the researchers show that tax changes have a stronger impact on innovation for firms with lower pledgeable income: firms with weaker governance, more financially-constrained firms, firms with fewer tangible assets, with a smaller patent stock, and firms that avoid taxes more. The researchers further alleviate endogeneity concerns by conducting numerous additional tests, such as showing that most of the impact of tax changes on innovation occurs two or more years after the change, and that tax changes have the opposite effect on firms operating in neighboring states.

Juan Carlos Suárez Serrato, Duke University and NBER, and Owen M. Zidar, University of Chicago and NBER

The Structure of State Corporate Taxation and its Impact on State Tax Revenues and Economic Activity

This paper documents facts about the state corporate tax structure — tax rates, base rules, and credits — and investigates its consequences for state tax revenue and economic activity. Suárez Serrato and Zidar present three main findings. First, tax base rules and credits explain more of the variation in the state corporate tax revenue than tax rates. Second, although states typically do not offset tax rate changes with base and credit changes, the effects of tax rate changes on tax revenue and economic activity depend on the breadth of the base. Third, as states have narrowed their tax bases, the relationship between tax rates and tax revenues has diminished. Overall, changes in state tax bases have made the state corporate tax system more favorable for corporations and are reducing the extent to which tax rate increases raise corporate tax revenue.

Mark Curtis, Wake Forest University, and Ryan Decker, Federal Reserve Board

Entrepreneurship and State Policy

Entrepreneurship plays an important role in labor markets, productivity growth, and occupational choices. While a large and growing literature studies patterns in entrepreneurial activity in the U.S., there exists little well-identified research into the policy determinants of entrepreneurial outcomes and the differing effects of policies on firms of different ages. Using the recently developed Quarterly Workforce Indicators dataset, Curtis and Decker examine the effect of corporate tax rates, personal tax rates, and other state-level policies on new firm activity by comparing contiguous counties that lie across state borders. The researchers estimate the effect of changes in these policies on employment and job flows at new firms. They find significant negative effects of corporate tax increases on the level of entrepreneurial activity, and find that new firms account for a disproportionate share of the response of aggregate employment growth to such tax changes. Other policies, such as the minimum wage, are shown to have modest effects that largely dissipate after accounting for cross border spillovers. The researchers find little evidence that personal tax rates affect entrepreneurial outcomes.

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