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New Federal Reserve Paper: State Corporate Taxes Hurt Entrepreneurship

By: Scott Drenkard

Add another study to the growing literature of the importance of state taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy on economic outcomes. On January 2nd, the D.C. branch of the Federal Reserve released an article by Professor E. Mark Curtis of Wake Forest University and Ryan A. Decker of the Federal Reserve examining how state tax policies impact employment at start-ups. They find that the corporate tax has the most robust identifiable impact on start-ups. In their words:

… [W]e find that increases in corporate tax rates have a statistically and economically significant negative effect on employment among start-up firms. Specifically, for every one percentage point increase in the corporate tax rate, employment in start-up firms declines 3.7 percent.

The way the researchers compare policies is quite interesting. Their report uses the newly-constructed Quarterly Workforce Indicators (QWI) firm age dataset, which allows researchers to isolate effects on new versus established firms. It also has local granularity that enables a comparison of economic outcomes in states against adjoining border counties in other states.

In essence, this allows you to hold demographic and industrial characteristics constant (because you are examining areas right next to each other), while examining impacts of changes in policy in one place against another.

Curtis and Decker, entrepreneurship and state taxation, corporate tax and start-ups, start-up tax policies,

Thought of another way, we often compare Illinois to Indiana, or Washington to Oregon, because the states have similar geographical position to one another and industrial makeup, but in some cases broadly different public policies. It makes less sense to compare Illinois to Wyoming or Maine to Nevada. Curtis and Decker employ a border counties comparison across the country for every state, giving them hundreds of observations across 14 observed years (2000-2013).

The finding of the significance of state corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es is in line with other studies on taxes and growth. Though the Curtis and Decker study only finds statistically significant impacts on start-up employment with regard to corporate income taxes (and does not find statistically significant results for individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. es or sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. es), corporate taxes are generally those that are considered most influential on economic growth in the literature.

For example, Jens Arnold et. al. of the Organisation for Economic Co-operation and Development (OECD) found in an extensive panel review that corporate income taxes are most harmful to growth, followed by personal income taxes, then consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. es, and finally property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. es.

By homing in just on the entrepreneurial start-up sector and just on state taxes, Curtis and Decker give us more insight into policies state policymakers can employ to nurture that upstart activity. The full Curtis and Decker study is available here, and worth a read.

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