Academic journal article The Cato Journal

A New Measure for the Variation of State Tax Prices

Academic journal article The Cato Journal

A New Measure for the Variation of State Tax Prices

Article excerpt

Richard Vedder's contributions to academic scholarship over the decades span many subdisciplines in economics. Many of his earlier works focused on various issues in state and local government finance. In a 1990 article, in this journal, he examined the relationship between interstate tax-price variation and state economic growth (Vedder 1990) to determine whether such variability might impact state prosperity and economic growth.

In part, Vedder's empirical analysis used the coefficient of variation across state tax prices in a given year to reveal whether "convergence" or "divergence" better described the behavior of state tax prices over time. He acknowledged that the results of this examination would be difficult to interpret because of confounding influences on the variability of state tax prices that are beyond the control of a state tax policy. This begs the question: Could a better measure of variability be constructed to control for such influences? This article attempts to do just that.

The first section of this article explains Vedder's methodology for measuring interstate tax-price variability and the challenging issues that he identified as confounding his attempt to determine whether such variability was rising or falling over time. The second section proposes a new measure for such variability and explores its usefulness in controlling for these confounding issues. The penultimate section uses empirical data to generate annual values of this measure across two decades of available tax data. The conclusion summarizes these results and considers how such information may drive forward the work that Vedder initially pursued.

Vedder's Methodology

To better understand the impact of state tax policy on prosperity and economic growth, Vedder describes two competing models that explain how states attract and sustain a viable tax base for supplying goods and services. Both models attempt to describe interstate tax policy as a competition between states, but die models produce dissimilar tax-price implications. According to one model, state governments compete primarily on tax price; this model predicts converging tax prices across state jurisdictions. In the other model, state governments compete on the quantity (or quality) of publicly funded goods and services; here the prediction is for divergent tax prices across states.

The first model Vedder considers is actually a blend of two separate models of public economics. The Brennan and Buchanan (1980) perspective assumes state governments behave like firms, selling goods and services to a customer base of taxpayers that is somewhat captive, due to nontrivial relocation costs. This is combined with Niskanen's (1971) perspective, in which bureaucratic rent-seeking activity causes the inefficient production of these goods and services. Any one state government's market power to set a tax price for supplying a given quantity of goods and services is limited by the ability of the taxpayers to migrate to another state that is perceived as offering a more favorable tax price. Further, if the inefficiency in supplying goods and services due to bureaucratic rent-seeking activity increases proportionately with the quantity of government goods and services produced, state taxpayer perceptions of tax prices relative to the value of state goods and services received worsens proportionately as well. This intensifies state taxpayers' search for a state jurisdiction with the best tax price for state-provided goods and services. The implication of this blended model is that state tax prices for goods and services tend to converge across states that compete on tax price to attract a sustainable base of taxpayers.

The second model that Vedder considers is that of Tiebout (1956), in which state taxpayers are assumed to have diverse preferences for the size and scope of state-provided goods and services. These taxpayers are assumed to be fairly mobile across state jurisdictions, with the ability to shop across a diverse collection of state-supplied baskets of goods and services, in an effort to find one that best fits their unique preferences. …

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