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State Taxation Policy and Economic Growth

State Taxation Policy and Economic Growth

by Michael Barker
     
 

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This volume discusses the problems of state governments in coping with contemporary issues of redesigning taxation policies to encourage economic growth.

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This volume discusses the problems of state governments in coping with contemporary issues of redesigning taxation policies to encourage economic growth.

Product Details

ISBN-13:
9780822398196
Publisher:
Duke University Press
Publication date:
06/01/2012
Series:
Duke Press policy studies
Sold by:
Barnes & Noble
Format:
NOOK Book
Pages:
303
File size:
786 KB

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State Taxation Policy


By Michael Barker

Duke University Press

Copyright © 1983 Duke University Press
All rights reserved.
ISBN: 978-0-8223-0535-4



CHAPTER 1

WHAT IS ECONOMIC DEVELOPMENT POLICY?


Economic development remains remarkably difficult to define positively. Specialists debate target rates of growth and unemployment, and unacceptable rates of inflation, but leave the central definition nebulous. In fact, this omission is understandable, at least from the viewpoint of public policy analysis. Economic development policy, at all levels of government, is best understood as the response to perceived problems, not as an attempt to meet targets.

The effectiveness of state and local development policies must be judged on the basis of their ability to redress those problems they have been developed to resolve. Tax policies are but one set of weapons in the armory of state economic development policy.


ECONOMIC DEVELOPMENT PROBLEMS

Economic development involves structural change in response to both market forces—technological change, rising in-comes, changing international and national growth patterns—and changes in federal, state and local policies. This adaptation is not without cost, nor is it borne equally by all geographic areas, firms, or population groups.

The costs of adjustment include the redevelopment of existing public and private capital, building new facilities, relocating firms and households, and acquiring new skills. These adjustments are not made instantly because employers and employees make decisions with imperfect knowledge about what opportunities are available now and what will happen in the future. Responsibility does not rest solely with workers—to move and to learn new skills—nor with firms—to incorporate new techniques and build new facilities—nor with local governments—to provide new services and adjust local taxes. Adjustment encompasses all these factors. Thesymptoms of imperfect adjustment are familiar: high local unemployment; the outmigration of firms and households; vacant buildings; low labor force participation rates; and declining income. Faced with these symptoms, the state government may respond in one of three ways: take no action, provide relief or compensation to those affected, or implement a corrective strategy. How it responds depends on its diagnosis of the causes of the problem. Inaction is appropriate if the problem is either not serious or better dealt with at the federal or local level. Relief, in the form of income transfers or municipal grants, is appropriate where the problem is temporary (a cyclical downturn), or is not susceptible to state policy action. A corrective strategy should be undertaken when public policies can effectively address a problem that will not rapidly disappear of its own accord. The focus of this paper is on the last type of response, and in particular, on how tax policies can address local development problems.

In designing a corrective strategy, the state must identify the causes of the economic problem. Why is the local unemployment rate so high? From the state's viewpoint, three classes of problems can be identified:

* Places. Local unemployment may be high because the area has lost its comparative advantage as a place to do business—its infrastructure may be obsolete, or its work force may be concentrated in declining industries.

* People. High unemployment may also reflect the characteristics of the local labor force. The young, ill-educated, or unskilled may experience high unemployment rates.

* Jurisdictions. A local jurisdiction may be unable to provide the population or services necessary for development. High local taxes resulting from a dependent local population, or a small per capita tax base, may slow growth.


Of course, these classes of problems are neither exhaustive nor exclusive. While all areas suffer some degree of economic distress for all of these reasons, the relative severity of distress differs among areas. A steel town in Ohio suffers primarily from a problem of place— its infrastructure is not suitable for modern steel production. High unemployment in the South Bronx may be caused by a lack of training for its residents, while Cleveland's fiscal problems are a jurisdictional problem. Nor are these reasons independent. A concentration of the hard-to-employ in a neighborhood will strain local government resources.

These classes of problems require different types of state policy response. Place problems are normally tackled by state public works projects—new industrial parks, expanded transportation links, and renovated buildings. People problems are addressed through training, work experience programs, and subsidized jobs. Jurisdictional problems have led to expanded grants to local areas and state assumption of local expenditures. Tax policies are part of each type of strategy: tax incentives are offered to firms moving into industrial parks; tax breaks are given to private firms training their workers; and tax sharing is used to help local jurisdictions. The goals of state tax policy are, therefore, interwoven with the more general goals of state economic development policy.


STATE ECONOMIC DEVELOPMENT GOALS

A state's economic development goals are to avoid, or at least lessen, local economic development problems. However, the achievement of these goals is complicated by the imprecise allocation of both fiscal and administrative responsibilities among federal, state and local governments in the "layer cake" structure of fiscal federalism. This section discusses state development goals and the ways in which they may conflict with national and local goals.


National Goals

In addition to pursuing their own goals, states are called upon—sometimes even compelled—to assist the federal government in meeting national objectives. Under the Federal Highway Act, states were called upon to contribute to the construction of a national highway network. States have also been nudged into improving income distribution, administering employment and training programs, abating pollution and enforcing equal rights legislation. Recently, they have been asked to help the Carter Administration in its fight against inflation. What can a state be reasonably expected to do to further national economic goals? How do national goals conflict with state goals?

The following considerations should guide state policy makers in attempting to comply with Washington's wishes:

[TABLE OMITTED]

Overall, with the exception of income redistribution, the ability of state economic policy to assist in the achievement of national macro-economic goals is limited.


State Goals

The most obvious purpose of state taxation is to raise revenue to cover state expenditures. However, other criteria are also considered in the process of deciding the structure and level of state taxes, and a state's policy toward local governments.

There are some obvious conflicts between state and national goals. First, and perhaps most important, the state goal of encouraging local growth may conflict with the national goal of balanced regional growth. Successful attempts by states to entice businesses away from other states may exacerbate interstate growth differentials. One state's gain is frequently another's loss. However, to the extent that a relocation allows a company to construct a more efficient plant and take advantage of better public infrastructure, national productivity may be enhanced. Overall, interstate competition is not productive. States in the Northeast have suffered under federal policies designed to raise the level of economic development in the low-income South. In fact, any federal regional strategy is bound to affect adversely economic development in non-target states unless the federal strategy addresses real market failure problems and succeeds in increasing total investment and employment so that all areas can gain.

A second conflict revolves around stabilization policy. The federal emphasis during the recent recession on construction activity— typified by the $6 billion Local Public Works Program—ran up against relatively tight construction markets in some states. Even in upstate New York, scarcely a booming construction area, there are reports that the construction schedule for the 1980 Winter Olympics facilities at Lake Placid was jeopardized by a lack of heavy construction firms able to bid as a result of their participation in a number of Local Public Works projects.

A third conflict is less obvious but just as important. Federal programs aimed at social goals may inadvertently slow development in some states. There is some evidence to suggest that abating pollution or enforcing safety and health conditions slow growth more in older central cities, where it is difficult to modify plant and equipment, than in faster growing areas. State officials must always be aware that a federal policy may have very different regional impacts, even though it is enforced nationwide.


Local Goals

Local jurisdictions have a set of goals similar to states, although applicable to their own smaller boundaries.

The most important area of potential conflict between states and local jurisdictions is between the state goal of balanced growth and the desire of many jurisdictions to maximize their own growth rate. Local jurisdictions can offer business tax incentives that attract businesses from distressed urban centers within the state. City/suburban tax differentials have played an important role in encouraging the suburbanization of jobs and households. This process is not necessarily desirable, for it can force a state government into the contradictory position of helping its suburban areas to accommodate business expansion and its central cities to redevelop abandoned facilities.

A second area of potential conflict is between the state's goal of assisting the poor and the desire of more affluent local jurisdictions to avoid redistributive taxes. The suburbanization of the nation's urban population has been accomplished through the proliferation of relatively homogeneous suburban communities that offer residents respite from central city tax burdens. These communities may not welcome increased state taxes that are channeled back into central cities. Until the last few years, this conflict has resulted in a marked unwillingness by state governments to involve themselves in the plight of central cities.

Another point of potential conflict occurs over the use of federal categorical and formula grants. Now that local areas are recipients of substantial amounts of federal funds for capital projects, the state can no longer ensure that local plans are coordinated— either with each other or with the state's own overall plan for state-funded projects. For example, a UDAG-financed shopping mall may not be effectively sited within the context of state transportation plans.


IMPLICATIONS

Two major conclusions can be drawn from this discussion. First, state economic development programs are undertaken in response to perceived problems—problems of place, people, or jurisdiction. The diagnosis of the causes of economic development problems—reflected in slow growth, high unemployment, and other familiar symptoms—affects the type of strategy implemented, and tax policy has a role within strategies aimed at each class of problems. But tax policy is only one weapon in an extensive armory of development policies. Other state actions include shifting program priorities, redesigning the geographic distribution of expenditures, and regulation of economic activity and local fiscal practices. The following chapter outlines the basic considerations that should guide state development policy makers in the design of their tax policies.

The second, more obvious conclusion is that there are clear conflicts between federal, state and local economic development goals. The principal conflicts between federal and state goals occur in the areas of balanced growth, income redistribution, and the inadvertent effects of broad federal social programs on local economies. State/local conflicts occur over interjurisdictional competition for growth, and in coordinating state and local development plans. As we shall see, these conflicts extend into the design and implementation of state tax policies.

CHAPTER 2

WHAT FACTORS INFLUENCE ECONOMIC DEVELOPMENT?


In trying to unravel the complex process of economic development to identify how state and local taxes may be influential, two facts stand out. First, state and local taxes are only one factor among many that directly influence development, and, in fact, are not a major factor. The role of taxes is not discussed in this chapter, but is discussed in detail in the following chapters. The discussion in this chapter provides a context in which to view the role of taxes. Second, many of the ways in which taxes shape the development process are indirect. For example, taxes affect residential location decisions which, in turn, affect the local demand for goods and services. A tax policy that attracted middle- and upper-income households would contribute to local development.


COMPONENTS OF EMPLOYMENT CHANGE1

Areas suffering from high unemployment often blame their difficulties on the out-migration of firms, and regard as a panacea an aggressive promotional campaign to attract new footloose firms. The myth of a rich vein of large, non-polluting firms that can be mined by state development officials offering free land and access roads, subsidized buildings, and tax abatements, has distorted state development efforts for years. A rational economic development policy cannot be developed until this myth is dispelled and the true components of employment change are identified. Recent studies on the location of industrial firms has revealed the following:

* Interregional migration of firms is the least important component of employment change. Differences in birth rates and the rate of expansion of existing firms are much more important. There is very little regional variation in the rate at which jobs are lost through firm contractions or closures.

* Firm moves are slightly more important in determining central city/suburban growth differences, but are still less important than other components.

* The birth rate of new firms is much higher in suburban locations than in central cities. Central cities do not tend to act as incubators.

* New, closing, and locally moving firms are smaller than stationary firms.

* Most new jobs in an area are created by the expansion of employment in relatively small, young, and independent firms.


What are the implications of these findings for development policy? Unfortunately, we don't yet know what factors affect each of the components of employment change, so it is difficult to target policies. Obviously, research in this crucial area should continue. We can say that any continued effort to chase smokestacks is probably misplaced, and that greater effort should be devoted to ensuring that the overall economic environment is as attractive as possible, rather than simply providing benefits to a few large firms. The remainder of this chapter examines the factors that influence development.


(Continues...)

Excerpted from State Taxation Policy by Michael Barker. Copyright © 1983 Duke University Press. Excerpted by permission of Duke University Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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