What do we know about taxes and economic development?

1
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

2
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?

3
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

4
Statistical/analytic studies--knowledge is fuzzy

• Era 1 1960s Taxes dont matter (John Due,
  1961) Context Opening up of American South,
  emergence of tax abatements
• Era 2 late 1970s Taxes likely matter, but
  were 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

5
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)

6
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)?

7
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

8
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?

9
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?

10
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).

11
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?)

12
Do we have a benefit-based system now?
Source William H. Oakland and William A. Testa
13
What would such a system look like?
Source William H. Oakland and William A. Testa
14
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/internaliz
  ation of direct prices at point of delivery will
  suffice)

15
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
  its a free lunch, or arent forced to choose)
• overspend
• not care about cost efficiency
• not be as careful about mix.
• And businesses will seek to avoid taxes even so

16
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

17
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?