“State Taxes and Spatial Misallocation”

That’s the title of a paper in this month’s issue of The Review of Economic Studies by Pablo Fajgelbaum, Eduardo Morales, Juan Carlos Suarez Serrato, and Owen Zidar. Here is the abstract:

We study state taxes as a potential source of spatial misallocation in the U.S.. We build a spatial general equilibrium framework that incorporates salient features of the U.S. state tax system, and use changes in state tax rates between 1980 and 2010 to estimate the model parameters that determine how worker and firm location respond to changes in state taxes. We find that heterogeneity in state tax rates leads to aggregate welfare losses. In terms of consumption equivalent units, harmonizing state taxes increases worker welfare by 0.6% if government spending is held constant, and by 1.2% if government spending responds endogenously. Harmonization of state taxes within Census regions achieves most of these gains. We also use our model to study the general equilibrium effects of recently implemented and proposed tax reforms.

One of the tax reforms studied is the deduction on State and Local Taxes, which was reduced (n.b. not eliminated) in the Tax Cuts and Jobs Act:

Eliminating SALT would increase dispersion in tax payments, since places with high state taxes and high-income taxpayers would pay even higher taxes. Consequently, we find that eliminating SALT reduces welfare by roughly 0.6% and aggregate real GDP by approximately 0.3% if government spending is held constant, and by 0.8% and 0.4%, respectively, if government spending responds endogenously. Southeastern states experience the largest gains. The hardest hit states are those with a large share of high income people and high tax rates, especially in the Northeast.

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