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State investment tax incentives: a zero-sum game?

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  • Robert S. Chirinko
  • Daniel J. Wilson

Abstract

Though the U.S. federal investment tax credit (ITC) was permanently repealed in 1986, state-level ITCs have proliferated over the last few decades. The proliferation of state ITCs and other investment tax incentives raises two important questions: (1) Are these tax incentives effective in achieving their stated objective, to increase investment within the state?; and (2) To the extent these incentives raise investment within the state, how much of this increase is due to investment drawn away from other states? To begin to answer these questions, we construct a detailed panel data set for 50 states for 20+ years (depending on the series). The data set contains series on output and capital, their relative prices, and the number of establishments. The effects of tax parameters on capital formation and establishments are measured by the Jorgensonian user cost of capital that depends in a nonlinear manner on federal and state tax parameters. Cross-jurisdiction differences in state investment tax credits and state corporate tax rates entering the user cost, combined with a panel that is long in the time dimension, are key to identifying the effectiveness of state investment incentives. Three models are estimated: (1) a Capital Demand Model motivated by the first-order condition for profit-maximization; (2) a Spatial Discontinuity Model developed by Holmes (1998) that exploits the spatial discontinuity in tax policies that occurs at state borders; and (3) a Twin-Counties Model that matches counties to a cross-border "twin" and relates between county differentials in manufacturing activity to between-county differentials in tax policy. The first model relies on state-level data, while the latter two use county-level data. On balance, the models find a significant channel for state tax incentives on own-state economic activity and document the importance of interstate capital flows, a necessary element for meaningful tax competition. Whether state investment incentives are a zero-sum game among the states is less certain and depends on the definition of the set of competitive states.

Suggested Citation

  • Robert S. Chirinko & Daniel J. Wilson, 2006. "State investment tax incentives: a zero-sum game?," Working Paper Series 2006-47, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfwp:2006-47
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    References listed on IDEAS

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    1. Chirinko, Robert S, 1993. "Business Fixed Investment Spending: Modeling Strategies, Empirical Results, and Policy Implications," Journal of Economic Literature, American Economic Association, vol. 31(4), pages 1875-1911, December.
    2. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
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    4. Robert S. Chirinko, 1992. "Business Fixed Investment Spending: A Critical survey of Modeling Strategies, Empirical Results, and Policy Implications," Working Papers 9213, Harris School of Public Policy Studies, University of Chicago.
    5. Chirinko, Robert S. & Wilson, Daniel J., 2017. "Tax competition among U.S. states: Racing to the bottom or riding on a seesaw?," Journal of Public Economics, Elsevier, vol. 155(C), pages 147-163.
    6. Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-529, October.
    7. Thomas J. Holmes, 1998. "The Effect of State Policies on the Location of Manufacturing: Evidence from State Borders," Journal of Political Economy, University of Chicago Press, vol. 106(4), pages 667-705, August.
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    9. Robert S. Chirinko & Daniel J. Wilson, 2006. "State investment tax incentives: what are the facts?," Working Paper Series 2006-49, Federal Reserve Bank of San Francisco.
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    13. Katharine L. Bradbury & Yolanda K. Kodrzycki & Robert Tannenwald, 1997. "Effects of state and local public policies on economic development: an overview," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 1-12.
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    Keywords

    Tax incentives ; Taxation ; State finance;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • 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

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