More on Taxes, Econ Dev’t
© Allen C. Goodman 2011
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Elasticities
• Remember elasticity!  Responsiveness!
• Elasticity of y with respect to x means that a
1% increase in x may increase y by 0.1%,
1.0%, or 10%.
• How do we calculate it?
• Eyx = (%Dy)/(%Dx)
• Eyx = (Dy/y)/(Dx/x)
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Elasticities
• Remember elasticity!
• Suppose there is a local sales tax of
1%. Suppose that you raise it to
1.5%. What was the percentage
increase?
• Ans> Dt/t = (1.5 - 1)/1.25.
• Why 1.25?
• Ans>Mid-point!
• So, Dt/t = (.5/1.25) = 0.4 or 40%.
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Elasticities
A Little!
• Elasticity of intermetropolitan business
activity (A) with respect to local tax
[(DA/A)/ (Dt/t)] varies between -0.1, and -0.6.
• Elasticity of intrametropolitan business
activity with respect to local tax varies
A Lot!!
between -1.0, and -3.0.
• Why are they so different?
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Elasticities
• What about simultaneous increases in
taxes and in public expenditures?
A> It depends!
• How are they spending the money?
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Tim Bartik
• Lots of this research follows work of
Tim Bartik.
• He’s at the Upjohn Institute in
Kalamazoo.
• Website is
http://www.upjohninst.org/staff/bartik.ht
ml
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General Approach
• Suppose the “true relationship is
Activity = a + b * taxes + c * services
• From this:
ΔA = b * Δ taxes
(ΔA/Δ taxes) = b
• This isn’t an elasticity
• THIS is an elasticity
We usually use means.
So we find mean taxes,
and mean level of activity.
EAt = (ΔA/Δ taxes) * (taxes/A) = b * (taxes/A)
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Bartik’s findings
• States and Metro Areas with higher (lower)
business tax rates will also tend, on average,
to have somewhat higher (lower) levels of
public services valued by business.
• Suppose the “true relationship is
– Activity = a + b * taxes + c * services
– If taxes and services move together, and we don’t
measure services, then lower taxes may “look”
ineffective when, in fact, it is the lower services
that are making the difference.
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Fixed Effects
• Third row looks at fixed effects.
• For example, if low wages, or nice
climate, mean that firms locate in the
South, rather than the fact that the
South may have low tax rates, then it
might make taxes look ineffective.
• When we control, taxes look more
effective.
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Intra- v. Inter-Metropolitan
• Studies that focus on variations in economic
growth among small suburbs within a
metropolitan area tend to find much more
negative effects of taxes on growth than is
found in looking at growth ACROSS
metropolitan areas or states.
• Not surprising – different suburbs w/in a
metro area are probably closer substitutes,
from a business perspective, than different
metro areas.
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Manufacturing v. Non-Manufacturing
• Manufacturing seems more sensitive than
non-manufacturing.
• Two plausible reasons
– Manufacturers are more oriented than nonmanufacturers to the national mkt and hence local
costs will have larger effects on their profits
because it will be harder to pass them on to
customers.
– Manufacturers tend to be more capital-intensive,
and many state and local business taxes are
essentially taxes on capital.
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-0.15 to -0.85
• Bartik takes away from this analysis
that the elasticity of state or metro area
business activity w.r.t. state and local
taxes is in the range of -0.15 to -0.85.
• Means a 10% reduction in state and
local business taxes  economic
activity by 1.5 to 8.5%. Is this a little or
a lot?
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A little or a lot?
•
0.85 and 0.15
are from
In early 1990s average ratio of state
and
previous slide.
business taxes to private employment
was
0.85  more
effective!
$1,620. It turns out that if you divide
this
number by the elasticity, you get the “cost of
one job” in foregone tax revenues.
• So, $1,620/0.85 = $1,906.
• And, $1,620/0.15 = $10,800.
• For a jurisdiction to permanently increase its
employment by one job compared to
otherwise, these are the costs.
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Turns out?
tax$
tax$
tax$
Dtax
job
job
/ Elas 


job
 Djob   Djob tax$  Djob
 job   Dtax job 


 
 Dtax$ 
 tax 
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Central Cities v. Suburbs
• Doesn’t seem to help central cities as
much as suburbs.
• Plausible that CC locations may not be
good substitutes for suburban
locations. If so, you may not get much
more redistribution.
• Most studies are not optimistic.
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Benefits and Costs
• Costs are somewhere between $1,906 and
$10,800 (1990)  Increase them by 50% since
then due to inflation.
• Business tax reductions financed by cutting
education or infrastructure spending will
probably destroy jobs.
• For suburbs they work, ONLY IF they are not
matched by other suburbs.
• Must balance labor market effects against
other items like traffic congestion.
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Some More Recent Work
• Wayslenko finds a range of elasticities
between -0.02 (not very big at all) and
-0.58.
• Most of them cluster around -0.1.
• WHY? If states are competing with each
other, net effect may not be very large.
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Impacts of Spending
• Ron Fisher (1997) “Some spending may
have positive effects in some cases.”
• Biggest impacts are transportation and
public safety spending.
• Education has more mixed effects
(probably because people can take
education and go elsewhere).
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What about jobs?
• How good is
this for local
people.
• Answer (Bartik
found): Not as
good as you
think.
• Why? People
may move in
from
elsewhere if
the jobs are
good jobs.
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Distribution of 1,000 New Jobs Between Residents and Newcomers
160 jobs
Newcomers
Original/Unemployed
Original/Not in Labor Force
70 jobs
770 jobs
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Development and Real Income?
– Wage increases
from higher paying
jobs
– Increases in labor
force participation
• These are larger for
less educated,
younger, AfricanAmerican.
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Effect of Employment Growth on Real Earnings Per Capita
0.6
Elasticity from 1% Increase in Total Employment
• Most important
factors in  in
income are:
0.5
0.4
0.3
0.2
0.1
0
Average
Less Educated
Younger
Black
Category
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Business Climate Studies
• Look at box on pages 666 – 668.
• Fisher notes that the professional
economists have trouble determining
what  development, investment.
• In a nutshell, most of the business
climate indices are worthless.
• See Peter (not Ron) Fisher, Grading
Places.
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Most Recent Work
• Bartik argues that we should concentrate
on what has been shown to WORK.
• Link
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What about
Michigan?
Source
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