Policy Seminar with Joshua Rauh

Friday, April 15, 2016
George Shultz Conference Room, Herbert Hoover Memorial Building

Josh Rauh, Terry Anderson, John Cogan, Rick Hanushek, Laurie Hodrick, Bob Hodrick, Nick Hope, Ken Judd, Tim Kane, Ed Lazear, Bobby McCormick, John Raisian, George Shultz, John Taylor, Yevgeniy Teryoshin

Joshua Rauh, Professor of Finance at the Stanford Graduate School of Business, discussed his work with Xavier Giroud on “State Taxation and the Reallocation of Business Activity: Evidence from Establishment-Level Data.”

Rauh first presented an overview of the debate on the effects of state business taxation on employment and business activity and the endogeneity issues in estimating these forces. State business taxation may depress economic activity and reallocate it across states by forming a wedge between pre-tax and after-tax profits but may, in principle, improve economic activity if it funds highly productive government investment. Rauh explores these effects using establishment level data on multi-state firms and estimates these effects by exploiting the fact that the corporate income tax affects C corporations, whereas pass-through entities are affected by personal income taxes, and these are changed by different states at different times. Rauh then exemplified the identification method and the role of differing apportionment factors across states on firms' tax burdens.

Rauh then reviews his results. A one percent increase in the state corporate income tax, which is on average a 20% increase in the state corporate tax rate, leads to the closing of .3% to .4% of C-corporations' establishments in the state within two years. A one percent increase in the state personal income tax leads to the closing of .2% to .3% of pass-through entities' establishments. Both tax increases also affect the employment rate at existing plants to the same magnitude but do not affect the alternate firm type. Of these effects, half are offset by reallocation across states indicating economically significant effects of tax competition across states.

Rauh concluded by discussing the robustness and external validity of the results. The results are robust to looking at only large tax changes, the narrative approach in the style of Romer and Romer (2010) leads to equivalent effects for all categories of tax changes, but he finds that small or single state firms do not respond to tax changes. He ended on a reminder that the results only capture the short run effects around local values.