The Evidence Regarding Taxes and Jobs

 

By

Moshe Adler

Dept. of Urban Planning

Columbia University

212 873 6803

ma820@columbia.edu

www.columbia.edu/~ma820

 

When deciding how to close states' and cities' budget gaps one of the questions that must be answered is whether a moderate tax increase by a city or a state--when the alternative is cuts in government services--would cause a gain or a loss of jobs.

 

The evidence from empirical studies subjected to peer review is that when tax increases prevent service cuts they also save jobs.  But the Beacon Hill Institute at Suffolk University in Boston has created its own unpublished model of the relationship between employment and taxes and its results differ sharply from those of the peer-reviewed studies. The Manhattan Institute relies on the Beacon Hill model to support its claim that increasing taxes will cost jobs, no matter what the circumstances are. Below is a brief review of the literature and of the Beacon Hill model.

 

The literature

 

The research on the effect of taxes on the economy experienced a great  leap forward with the publication in 1985 of the article “The Effect of  State and Local Taxes on Economic Growth:  A Time Series-Cross Section  Approach” by University of California economist Jay Helms.[1]  Instead of  treating government as a black hole into which funds disappear, Helms  included in his study both the taxes paid and the services  financed  by these taxes.  Helms discovered  that expenditures on health,  highways, schools and higher education cause growth in a state's personal  income.  The only expenditure that caused a decrease in a state's personal income  in Helms' study was welfare; interestingly, this is also the only result that did  not withstand the test of time, because it was unique to a particular  time-period.  Carroll and Wasylenko (1994) discovered that the effect of  welfare payments on employment is mostly limited to employment in  manufacturing and that the effect on manufacturing was present in the  1970s but not in the 1980s.[2], [3] (Helms' data are for the years 1965-1979). 

 

 

Helms' study remains the last word in estimating the empirical effect  that taxes have on economic performance overall.[4]  Other researchers  examined more limited issues that are relevant to the effect of taxes. 

 

--Bartik (1989) found that increased spending on local schools and fire protection increases the creation of small businesses.[5]

 

 --Munnell (1990) found that tax increases that finance improvements to  highways, sewage systems and other infrastructure increase the growth  rate of private employment.[6]

 

 --Bartik (1996) found that increased spending on higher education and  health, financed by property tax increases, stimulate state  manufacturing output.[7]  On the other hand, increases in spending on  roads, financed by non-property tax increase, reduce manufacturing  employment in the long run. According to Bartik's findings all other tax increases had  little impact on economic performance.

 

 

The Beacon Hill Model and the Haughwout et al.  model

 

The Beacon Hill Institute applied its model, called State Tax Analysis  Modeling Program, or STAMP, to New York State and City.  Economists Andrew Haughwout, Robert Inman, Steven Craig  and Thomas Luce, researchers at the National Bureau of Economic  Research, also constructed a model of employment and taxes in New  York City.  This model is strikingly similar to the Beacon Hill study and achieves a similar result.

 

As we show in an article in a State Tax Notes article[8] and in an as  yet unpublished response to a rebuttal by the Beacon Hill Institute,[9] the  Beacon Hill studies and the study by the NBER researchers are  fatally flawed. Briefly, the main  problems with these studies are:

 

 1.  The studies account for taxes in only one jurisdiction. Thus, in the  case of New York City, the studies contain information only about the  city itself.  As the data that  these studies use show, between 1989 and  1992 private sector employment in NYC fell by 10% at the same time that  the top personal income tax rate increased by 31%.  But these studies  completely ignore the fact that New Jersey raised its top rate by a  whopping 90% and Connecticut instituted its first state income tax  during the same period.  New Jersey and Connecticut are often described  as competing with New York City for jobs, and their inclusion in the  study is therefore mandatory.  It should be noted that Helms' study contains tax data  for all the relevant jurisdictions, states in his case, and this is one  reason why his results are so different.

 

 2.  The Beacon Hill Institute and the Haughwout et al.  studies do not  control for employment, wages or rates of unionization across competing jurisdictions.  Thus  it is impossible to know whether employment is determined by regional economic conditions (such as the loss of jobs that affected the whole urban Northeast in the 1970s)[10] and/or by labor market conditions or by taxes.

 

3.  In the Beacon Hill Institute and the Haughwout et al. studies state  and city services play no role.  In the Beacon Hill studies the only thing the  government does is pay welfare and unemployment, and these are the only  expenditures that are included.  In the study by Haughwout et al. only  transfer payments from the federal government and the state are  included.    Expenditures on schools, police and roads are missing in  all these studies.  Thus the Beacon Hill and the Haughwout et al.  studies do  not tell us whether taxes have an effect on employment at all, and if they do what this effect is.

 

 Conclusion         

 

The empirical evidence is that cuts in  government services in order to  avoid tax increases will result in a reduction in incomes and therefore  jobs.  Claims to the contrary are based on research that is deliberately shoddy.

 

 

 

 



[1] L. Jay Helms, “The Effect of State and Local Taxes on Economic Growth:  A Time Series-Cross Section Approach,” The Review of Economics and Statistics, 1985, pp. 574-582.

[2] Carroll, Robert, and Michael Wasylenko, “Do State Business Climates Still Matter:  Evidence of a Structural Change.”  National Tax Journal, Vol. 47 (March), 1994, 19-37.

 

[3] Helms’ result regarding welfare payments probably confuses cause and effect.  The 1970s saw a restructuring of the U.S. economy, with employment migrating from cities to suburbs and from the sun belt to the snow belt. As a result, personal incomes in urban Northeastern states declined during that period and because of this decline in incomes welfare payments increased.  See Moshe Adler, Oliver Cooke and James Parrott,  “Do Tax Increases In New York Cause a Loss of Jobs?  A Review of the Evidence,” State Tax Notes, Feb. 4 2002.  (www.columbia.edu/~ma820/State.Tax.Notes.pdf)

[4] See Robert G. Lynch, Do State & Local Tax Incentives Work?  Economic Policy Institute, 1996, and Michael Wasylenko, “Taxation and Economic Development:  The State of Economic Literature,” New England Economic Review, March/April 1997, 37-52.

[5] Bartik, Timothy, “Small Business Start-Ups in the United States:  Estimates of the Effects of Characteristics of States.”  Southern Economic Journal, Vol. 55, No. 4, pp.  1004-18.

[6] Munnell, Alicia, 1990. “How Does Public Infrastructure Affect Retinjal Economi Performance?”  New England Economic Review  (September/October), pp. 11-13.

[7] Bartik, Timothy, Growing State Economies:  How Taxes and Public Services Affect Private Sector Performance,  The Economic Policy Institue, 1996.

[8]Moshe Adler, Oliver Cooke and James Parrott,  “Do Tax Increases In New York Cause a Loss of Jobs?  A Review of the Evidence,” State Tax Notes, Feb. 4 2002.

[9] Moshe Adler, “Response to the Confusers,” unpublished working paper.

[10] See footnote 3 above.