What do we know about taxes and economic development?

What do we know about taxes and economic development? Remarks presented by William A. Testa (Federal Reserve Bank of Chicago) to “Taxing and Spending Limits in Wisconsin” conference, January 19, 2005

Taxes and growth: What is the question? (2 approaches) • How much do tax levels/changes matter? • What should policy makers do with respect to taxes? • What is “good government”? • How does tax level and policy follow from our tenets of good government?

Taxes and growth: 1st approach • How much do tax levels/changes matter? • What should policy makers do with respect to taxes? • Problematic unless way out of line…..why? • not largest factor, knowledge is very fuzzy • services matter too (both business & households) • “an old tax is a good tax”

Statistical/analytic studies--knowledge is fuzzy • Era #1 1960s “Taxes don’t matter” (John Due, 1961) Context: Opening up of American South, emergence of tax abatements • Era #2 late 1970s “Taxes likely matter, but we’re not sure” (Oakland, 1977) Context: Tax revolts, collapse of NY, central cities, New England region • Era #3 1980s/90s “Taxes matter, if not most important” Context: Globalization, mobility

Analytic studies (challenges) • INTER-regional studies • challenge to control for other variables (wages, transportation, market growth, public services) • taxes not largest cost share • neighboring states often “stay within convoy” • causality of tax burden and growth confounded by two-way causation (e.g. Colorado, economic decline of large central cities)

Outliers as case studies • Taxes easier to see in New York State, perhaps California too • but confounding, high and narrow taxes as part of “bad business climate” and reputation • If tax climate bad, usually so is regulatory, services, responsiveness of government • can a business investor take the chance of being a convenient cash cow in the next emergency(Illinois 2003)?

Analytic studies--findings • Taxes do (or can) matter • elasticities of .1 - .6 (closer to .2) • …and depends on neighbors, competitors, industries • spending and services mix matter, too • effects seemingly larger within metro areas

What to do? • Keep business taxes low and broad-based • But what else? How much, and How much emphasis for those places in the vast middle?

2nd Approach: What is “good government”? • “Good” for businesses and households alike • Government provides right mix of services in proper amounts, at lowest possible cost • Market-like situations often accomplish the same….. • Benefit principle of taxation (user fees) • Ability to pay (redistribution) • Can we have good government without proper “price signals? But if so, what about the poor and disadvantaged?

Benefit principle and business taxation • Businesses do consume and value services (e.g. SIDs, statistical studies etc.) • Businesses should have a voice in mix and level of service provision (the piper calls the tune) • Business should pay for services so as to: • assure provision as desired • and to encourage cost efficiency in provision (every spenders are more careful w/their own money than when spending the money of others).

Benefit principle approach to business taxation and development • User fees if possible (the most direct mechanism) • Statewide “activity tax” on all business at low rate for other services….. • Framework for dialogue between business community and state government on business service levels and mix • Selective tax incentives not prohibited, but natural incentives to do so are greatly reduced • ?On the contrary? Should business make choices on household services? (no, not Pullman, but why do we often see business become involved?)

Do we have a benefit-based system now? Source: William H. Oakland and William A. Testa

What would such a system look like? Source: William H. Oakland and William A. Testa

Benefit principle and household taxation (for the same reasons) • User fees if possible (e.g. tollways and refuse) • Devolution of service provision to smallest geography (to encourage customization and cost discipline) compatible with extent of benefits and benefit spillovers…(e.g. environment, highways, and some land use regulation statewide, schools locally if scale permits etc.) • Explicit approval needed for spending hikes • TABOR then needed? (perhaps realization/internalization of direct prices at point of delivery will suffice)

Why not tax business to fund household services? • Tax shifting and flight the norm in long run, and the long run does come before we are dead (ask Castro and soon, Putin). • Americans like their taxes hidden, and workers may work for lower wages with lower tax burden, but even if so, households will (if they believe it’s a free lunch, or aren’t forced to choose) : • overspend • not care about cost efficiency • not be as careful about mix. • And businesses will seek to avoid taxes even so

What about equity and income redistribution? • Ability to “export” business burden out of state is very limited; likewise, tax shifting to labor and forward in consumer prices is the norm anyway • Can we fund from households? • Largest geography of household tax burden to benefit poor desired, • but maintain local control of spending if possible (e.g. education, carry coupon on their backs) • Proximity to poor to be encouraged

Conclusions • Taxes matter for growth and development, though within most existing boundaries, they are not single most-critical influence on observed inter-regional growth differences • Simple changes to tax levels reserved for outliers? • Good government matters to growth and development, not only for businesses, but for their employees (taxes are a part of that good civics climate) • Can we have good government without proper price signals, dialogue, and consumer discipline between govt. and its households and businesses? • Is good government a better solution than TABOR?

What do we know about taxes and economic development?