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Donald Bruce, Xiaowen Liu, and Matthew Murray Center for Business and Economic Research and Department of Economics The University of Tennessee, Knoxville Conference on Subnational Government Competition The University of Tennessee April 25, 2014 State Tax Policy and Entrepreneurship

State Tax Policy and Entrepreneurship

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State Tax Policy and Entrepreneurship. Donald Bruce, Xiaowen Liu, and Matthew Murray Center for Business and Economic Research and Department of Economics The University of Tennessee, Knoxville Conference on Subnational Government Competition The University of Tennessee April 25, 2014. - PowerPoint PPT Presentation

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Page 1: State Tax Policy and Entrepreneurship

Donald Bruce, Xiaowen Liu, and Matthew MurrayCenter for Business and Economic Research and

Department of EconomicsThe University of Tennessee, Knoxville

Conference on Subnational Government CompetitionThe University of Tennessee

April 25, 2014

State Tax Policy and Entrepreneurship

Page 2: State Tax Policy and Entrepreneurship

• States have a long history of using income and sales tax policy to compete for mobile entrepreneurs and/or encourage new ones– 2012: Kansas removes income tax on pass-

through income– 2014: Missouri considers 25% deduction of pass-

through income– Other states considering income tax repeal, with

small business promotion as one selling point• Empirical literature has not generally

supported this at the state level

Policy Background

Page 3: State Tax Policy and Entrepreneurship
Page 4: State Tax Policy and Entrepreneurship

• Intensive-margin indicators of success–Most prior work is on extensive margin– Policy makers care more about success

• Dynamic panel regression–Most prior work uses fixed effects–Underlying trends matter

• Expanded specification and time period– 1978-2009

Contributions

Page 5: State Tax Policy and Entrepreneurship

• Nonfarm Proprietors’ Income (NFPI)– Per capita– As a % of total state personal income– As a % of national NFPI

• Nonfarm Proprietors’ Employment (NFPE)– As a % of total state employment– As a % of national NFPE

• Nonfarm Proprietors’ Productivity– NFPI/NFPE

Measures of Performance

Page 6: State Tax Policy and Entrepreneurship

• Past performance can predict future• Arellano-Bond (1991) estimator

– Y is the outcome of interest– X includes state policy characteristics– Z includes state economic/demographic

factors– is a state fixed effect– is a year fixed effect– is a well-behaved error

Empirical Approach

Page 7: State Tax Policy and Entrepreneurship

• Addresses time series issues in panel data

• Model transformed to first-difference– Removes state fixed effect

• Inclusion of lagged Y raises endogeneity concern; external instruments not required

• Arellano-Bover (1995) / Blundell-Bond (1998) approach used as an alternative

AB 101

Page 8: State Tax Policy and Entrepreneurship

• Policy– Sales tax rate– Top marginal personal income tax (PIT) rate– Top marginal corporate income tax (CIT) rate– Sales factor weight in CIT apportionment– Per capita state government expenditures– Tax Amnesty programs

• Economic/Demographic– Unemployment rate– % of population aged 65 and older– Crime rate– % female– Agricultural, Manufacturing % of GSP– Nonfarm job growth– Population density

Independent Variables

Page 9: State Tax Policy and Entrepreneurship

NFPI and NFPE, 1978-2009

$0

$200,000,000

$400,000,000

$600,000,000

$800,000,000

$1,000,000,000

$1,200,000,000

$1,400,000,000

0

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

NFPI (left)NFPE (right)

Page 10: State Tax Policy and Entrepreneurship

NFPI/E Shares and Productivity

0.000

0.050

0.100

0.150

0.200

0.250

0.000

5.000

10.000

15.000

20.000

25.000

30.000

35.000

40.000

45.000NFPE Share (left)NFPI Share (left)NFProductivity (right)

Page 11: State Tax Policy and Entrepreneurship

Summary StatisticsVariable 1978 2009

NFPI ($1,000) 9,666,381 17,900,000

NFPI per capita 2,189 2,745

NFPI as a share of total income (%) 8.36 7.06

State share of national NFPI (%) 2 2

NFPE (1,000) 256,572 708,628

NFPE as a share of total employment (%) 12.21 20.05

State share of national NFPE 2 2

Nonfarm proprietors’ productivity 35,784 23,247

Page 12: State Tax Policy and Entrepreneurship

Summary StatisticsVariable 1978 2009Sales tax rate 3.54 5.07Top PIT rate 6.90 5.47Top CIT rate 5.95 6.56Expenditures per capita 2.88 5.55Sales factor weight 32.3 57.2Unemployment rate 5.62 8.45Age > 64 10.72 13.16Crime rate 4.39 2.94Female percentage 51.02 50.58Nonfarm job growth 5.72 -4.18Agriculture share of GSP 3.90 1.61Manufacturing share of GSP 20.91 11.10Population density 153 193Amnesty 0 0.14

Page 13: State Tax Policy and Entrepreneurship

AB Results 

NFPI NFPE 

Per CapitaAs a Share of

Total Income

State Share of National NFPI

As a Share of Total

Employment

State Share of

National NFPE

 Productivity

Sales tax rate –0.009 0.009 –0.017 –0.019 0.004 –0.052  (0.016) (0.042) (0.014) (0.016) (0.024) (0.193)Top PIT rate 0.006 0.028 –0.001 0.001 –0.005 –0.030  (0.011) (0.029) (0.006) (0.012) (0.004) (0.138)Top CIT rate –0.009 –0.020 0.007 –0.004 –0.003 –0.173  (0.019) (0.047) (0.047) (0.012) (0.005) (0.188)Expend. per capita 0.051 0.104 0.044 0.063 0.0004 0.760***  (0.045) (0.077) (0.032) (0.050) (0.016) (0.186)Sales factor weight –0.001* –0.001 0.0002 0.001 –0.0002 –0.011**  (0.001) (0.001) (0.001) (0.001) (0.0002) (0.005)

Page 14: State Tax Policy and Entrepreneurship

• Main result echoes Bruce & Deskins (2012): taxes generally don’t matter– Higher sales factor weight lower NFPI per capita and lower NFP

productivity– Higher state gov’t. expend. per capita higher NFP productivity

• Other controls matter– Higher unemployment higher NFPI/E shares– Older population lower NFPE share; higher NFP productivity– Higher NF job growth higher NFPI/E shares; lower NFP

productivity– Lower crime rate higher NFPI per capita– Higher pop. Density higher NFPE share– Lower GSP shares in manufacturing or agriculture higher NFPI

• Lags always matter (dynamic specification is important)

Discussion

Page 15: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins

Sales tax rate 0.065

Top PIT rate –0.046

Top CIT rate –0.025

Expend. per capita –0.028

Sales factor weight –0.001

Page 16: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins Arellano-Bond

Sales tax rate 0.065 –0.019

Top PIT rate –0.046 0.001

Top CIT rate –0.025 –0.004

Expend. per capita –0.028 0.062

Sales factor weight –0.001 0.001

Page 17: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins Arellano-Bond

Simple Replication

Sales tax rate 0.065 –0.019 0.043

Top PIT rate –0.046 0.001 –0.015

Top CIT rate –0.025 –0.004 –0.079**

Expend. per capita –0.028 0.062 0.051

Sales factor weight –0.001 0.001 0.003

Page 18: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins Arellano-Bond

Simple Replication

Simple Replication and

Different Controls

Sales tax rate 0.065 –0.019 0.043 0.019

Top PIT rate –0.046 0.001 –0.015 0.023

Top CIT rate –0.025 –0.004 –0.079** –0.086***

Expend. per capita –0.028 0.062 0.051 0.096

Sales factor weight –0.001 0.001 0.003 0.004***

Page 19: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins Arellano-Bond

Simple Replication

Simple Replication and

Different Controls

Simple Replication and Different Time

Sales tax rate 0.065 –0.019 0.043 0.019 –0.216***

Top PIT rate –0.046 0.001 –0.015 0.023 –0.010

Top CIT rate –0.025 –0.004 –0.079** –0.086*** –0.062**

Expend. per capita –0.028 0.062 0.051 0.096 0.038

Sales factor weight –0.001 0.001 0.003 0.004*** 0.002

Page 20: State Tax Policy and Entrepreneurship

Comparison to Bruce & Deskins (2012)

Employment stockBruce & Deskins Arellano-Bond

Simple Replication

Simple Replication and

Different Controls

Simple Replication and Different Time

Simple Replication and Arellano-Bond

Sales tax rate 0.065 –0.019 0.043 0.019 –0.216*** –0.046

Top PIT rate –0.046 0.001 –0.015 0.023 –0.010 0.117***

Top CIT rate –0.025 –0.004 –0.079** –0.086*** –0.062** 0.002

Expend. per capita –0.028 0.062 0.051 0.096 0.038 0.003

Sales factor weight –0.001 0.001 0.003 0.004*** 0.002 0.008**

Page 21: State Tax Policy and Entrepreneurship

• Simply adding (1) variables or (2) years of data or (3) estimating an AB model would have generated misleading significance

• The combination of these three updates is important

• The additional years of data (2003-2009) are enough to drive the importance of a dynamic estimation approach

Discussion