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Tax Competition Among U.S. States: Racing to the Bottom or Riding on a Seesaw?

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  • Robert S. Chirinko
  • Daniel J. Wilson

Abstract

Dramatic declines in capital tax rates among U.S. states and European countries have been linked by many commentators to tax competition, an inevitable “race to the bottom,” and underprovision of local public goods. This paper analyzes the reaction of capital tax policy in a given U.S. state to changes in capital tax policy by other states. Our study is undertaken with a novel panel data set covering the 48 contiguous U.S. states for the period 1965 to 2006 and is guided by the theory of strategic tax competition. The latter suggests that capital tax policy is a function of “foreign” (out-of-state) tax policy, preferences for government services, home state and foreign state economic and demographic conditions. The slope of the reaction function–the equilibrium response of home state to foreign state tax policy–is negative, contrary to casual evidence and many prior empirical studies of fiscal reaction functions. This result, which stands in contrast to most published findings, is due to two critical elements–allowing for delayed responses to foreign tax changes and for heterogeneous responses to aggregate shocks. Omitting either of these elements leads to a misspecified model and a positively sloped reaction function. Our results suggest that the secular decline in capital tax rates, at least among U.S. states, reflects synchronous responses among states to common shocks rather than competitive responses to foreign state tax policy. While striking given prior empirical findings, these results are fully consistent with the qualitative and quantitative implications of the theoretical model developed in this paper and presented elsewhere in the literature. Rather than “racing to the bottom,” our findings suggest that states are “riding on a seesaw.” Consequently, tax competition may lead to an increase in the provision of local public goods, and policies aimed at restricting tax competition to stem the tide of declining capital taxation are likely to be ineffective.

Suggested Citation

  • Robert S. Chirinko & Daniel J. Wilson, 2011. "Tax Competition Among U.S. States: Racing to the Bottom or Riding on a Seesaw?," CESifo Working Paper Series 3535, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_3535
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    Cited by:

    1. Anping Chen & Marlon Boarnet & Mark Partridge & Yongzheng Liu & Jorge Martinez-Vazquez, 2014. "Interjurisdictional Tax Competition In China," Journal of Regional Science, Wiley Blackwell, vol. 54(4), pages 606-628, September.
    2. Michael P. Devereux & Simon Loretz, 2013. "What Do We Know About Corporate Tax Competition?," National Tax Journal, National Tax Association;National Tax Journal, vol. 66(3), pages 745-774, September.
    3. Robert S. Chirinko & Daniel J. Wilson, 2010. "State business taxes and investment: state-by-state simulations," Economic Review, Federal Reserve Bank of San Francisco, pages 13-28.
    4. Assaf Razin & Efraim Sadka, 2013. "Migration and Fiscal Competition within a Union," NBER Working Papers 19282, National Bureau of Economic Research, Inc.
    5. Paul Maarek & Renaud Bourlès & Michael T.Dorsch, 2014. "Income Redistribution and the Diversity of Consumer Goods," THEMA Working Papers 2014-21, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    6. Isen, Adam, 2014. "Do local government fiscal spillovers exist? Evidence from counties, municipalities, and school districts," Journal of Public Economics, Elsevier, vol. 110(C), pages 57-73.
    7. Moretti, Enrico & Wilson, Daniel J., 2014. "State incentives for innovation, star scientists and jobs: Evidence from biotech," Journal of Urban Economics, Elsevier, vol. 79(C), pages 20-38.
    8. Chirinko, Robert S. & Wilsom, Daniel J., 2010. "Can Lower Tax Rates Be Bought? Business Rent-Seeking and Tax Competition Among U.S. States," National Tax Journal, National Tax Association;National Tax Journal, vol. 63(4), pages 967-993, December.
    9. David Staubli, 2018. "The Elasticity of Corporate Income: Panel Data Evidence from Switzerland," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 18.01, Université de Lausanne, Faculté des HEC, DEEP.
    10. Pete Maniloff & Dale T. Manning, 2015. "Division of Nonrenewable Resource Rents: A Model of Asymmetric Nash Competition with State Control of Heterogeneous Resources," Working Papers 2015-08, Colorado School of Mines, Division of Economics and Business.
    11. Chirinko, Robert S. & Wilson, Daniel J., 2008. "State investment tax incentives: A zero-sum game?," Journal of Public Economics, Elsevier, vol. 92(12), pages 2362-2384, December.
    12. Li, Kunpeng, 2018. "Spatial panel data models with structural change," MPRA Paper 85388, University Library of Munich, Germany.
    13. Baskaran, Thushyanthan & Lopes da Fonseca, Mariana, 2013. "The economics and empirics of tax competition: A survey," Center for European, Governance and Economic Development Research Discussion Papers 163, University of Goettingen, Department of Economics.
    14. Raphael Parchet, 2014. "Are Local Tax Rates Strategic Complements or Strategic Substitutes?," IdEP Economic Papers 1407, USI Università della Svizzera italiana.
    15. Raphael Parchet, 2012. "Are Local Tax Rates Strategic Complements or Substitutes?," ERSA conference papers ersa12p313, European Regional Science Association.
    16. Calin Arcaelan, 2015. "International Tax Competition and the Deficit Bias," CESifo Working Paper Series 5627, CESifo Group Munich.
    17. Till Gross, 2013. "Capital Tax Competition and Dynamic Optimal Taxation," Carleton Economic Papers 13-08, Carleton University, Department of Economics.

    More about this item

    Keywords

    tax competition; state taxation; reaction functions; capital taxation;

    JEL classification:

    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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