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State capital taxes and the location of investment: empirical lessons from theoretical models of tax competition

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  • Brian Knight

Abstract

Applying insights from theoretical tax competition models, this study of manufacturing investment and taxes in U.S. states makes four contributions to the empirical tax competition literature. First, while the existing empirical literature has assumed exogenous tax rates, the theoretical model, which endogenizes state tax rate choices, demonstrates that tax rates and investment decisions are determined by the same set of jurisdiction characteristics. The endogeneity corrected estimates, which rely on instruments motivated by the theoretical model, suggest stronger responses to tax rates than the uncorrected estimates in both this paper and the existing literature. The second insight involves the appropriate unit of observation. The empirical literature has conducted both aggregate analyses, in which jurisdictions are the unit of observation, and discrete choice analyses, in which manufacturing plants are the unit of observation. While the tax competition model demonstrates the violation of a key assumption in discrete choice analyses, the estimating equation in this paper, an aggregate analysis, can be derived directly from the model. Third, the theoretical model sheds light on the appropriateness of previously employed measures of tax burdens. The effective tax rate is shown to be superior to the after-tax rate of return, which is both invariant across jurisdictions and dependent on the distribution of investment. Fourth, this paper provides estimates of the degree of undertaxation of capital, which has been the focus of the theoretical tax competition literature but has yet to be addressed empirically. These estimates suggest that the efficient revenues may be as much as two times the size of actual revenues.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2002-59.

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Date of creation: 2002
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Handle: RePEc:fip:fedgfe:2002-59

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Keywords: State finance ; Taxation;

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References

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  1. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 269-304, June.
  2. Leslie E. Papke, 1989. "Interstate Business Tax Differentials and New Firm Location: Evidence from Panel Data," NBER Working Papers 3184, National Bureau of Economic Research, Inc.
  3. Auerbach, Alan J. & Hines, James Jr., 2002. "Taxation and economic efficiency," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 21, pages 1347-1421 Elsevier.
  4. Timothy J. Bartik, 2004. "Economic Development," Book chapters authored by Upjohn Institute researchers, in: J. Richard Aronson & Eli Schwartz (ed.), Managememnt Policies in Local Government Finance, pages 355-390 W.E. Upjohn Institute for Employment Research.
  5. Wallace E. Oates, 1999. "An Essay on Fiscal Federalism," Journal of Economic Literature, American Economic Association, vol. 37(3), pages 1120-1149, September.
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  7. Balestra, Pietro & Varadharajan-Krishnakumar, Jayalakshmi, 1987. "Full Information Estimations of a System of Simultaneous Equations with Error Component Structure," Econometric Theory, Cambridge University Press, vol. 3(02), pages 223-246, April.
  8. Boozer, Michael A., 1997. "Econometric Analysis of Panel Data Badi H. Baltagi Wiley, 1995," Econometric Theory, Cambridge University Press, vol. 13(05), pages 747-754, October.
  9. Michael Wasylenko, 1997. "Taxation and economic development: the state of the economic literature," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 37-52.
  10. James R. Hines Jr., 1993. "Altered States: Taxes and the Location of Foreign Direct Investment in America," NBER Working Papers 4397, National Bureau of Economic Research, Inc.
  11. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
  12. Douglas Staiger & James H. Stock, 1997. "Instrumental Variables Regression with Weak Instruments," Econometrica, Econometric Society, vol. 65(3), pages 557-586, May.
  13. Zodrow, George R. & Mieszkowski, Peter, 1986. "Pigou, Tiebout, property taxation, and the underprovision of local public goods," Journal of Urban Economics, Elsevier, vol. 19(3), pages 356-370, May.
  14. Carlton, Dennis W, 1983. "The Location and Employment Choices of New Firms: An Econometric Model with Discrete and Continuous Endogenous Variables," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 440-49, August.
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Cited by:
  1. Claudio Agostini & Ileana Raquel Jalile, 2006. "Efectos del Impuesto a las Utiildades en la Inversión Extranjera en América Latina," ILADES-Georgetown University Working Papers inv174, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  2. Sergii Slukhai, 2009. "Inter-Location Small Business Tax Rate Variation in Ukraine: What Is Behind It?," Financial Theory and Practice, Institute of Public Finance, vol. 33(1), pages 49-71.

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