On the effectiveness of state tax and expenditure policies to encourage entrepreneurship
| Published date | 02 December 2019 |
| Date | 02 December 2019 |
| Pages | 523-548 |
| DOI | https://doi.org/10.1108/JEPP-03-2019-0020 |
| Author | Donald Bruce,Elizabeth A. Glass,Matthew C. Harris |
| Subject Matter | Strategy |
On the effectiveness of state tax
and expenditure policies to
encourage entrepreneurship
Donald Bruce
Department of Economics and Boyd Center for Business and Economic Research,
University of Tennessee, Knoxville, Tennessee, USA
Elizabeth A. Glass
Labor Market and Economic Analysis Division,
Washington State Employment Security Department,
Olympia, Washington, USA, and
Matthew C. Harris
Department of Economics and Boyd Center for Business and Economic Research,
University of Tennessee, Knoxville, Tennessee, USA
Abstract
Purpose –The purpose of this paper is to expand the empirical literature on state tax and expenditure
policies and entrepreneurial activity in several meaningful ways.
Design/methodology/approach –The authors update the panel data to include several more recent years
and also consider other elements of state policy.
Findings –The most important takeaway is that even after dealing with some of the known shortcomings of
dynamic panel analysis, we are still not able to find economically meaningful impacts of state tax and
expenditure policies (generally defined) on entrepreneurial performance.
Research limitations/implications –Earlierstudies that have found statisticalsignificance have generally
been limited to extensive-margin impacts on such things as self-employment rates or counts of new or small
firms. Whenthe authors examine whatpolicy makers actually careabout –things like income and employment
among entrepreneurial ventures –the authorsdo not find much in the way of useful policy impacts.
Practical implications –To be sure, the authors find entrepreneurial performance to be statistically
significantly related to certain tax rates and expenditure amounts, but the magnitudes of our estimated
results cast serious doubts on the usefulness of these particular policy levers for generating meaningful
improvements in entrepreneurial success.
Originality/value –The authors’primary contribution is to improve the empirical consideration of the time
series properties of the data. The authors provide a battery of more general and robust analyses to more
completely surround the question.
Keywords Entrepreneurs, Tax policy, Firm performance, Sub-national government, Fiscal policy,
Government spending
Paper type Research paper
Introduction
The link between tax policy and entrepreneurship has often been included by state
legislators as a justification for lowering state tax rates. In an effort to support
entrepreneurship, employment, and both local and regional economic development, state
governments argue that lower taxes attract new businesses and foster entrepreneurial
activity. As a result, small-business-friendly legislation has been and continues to be
popular among state policy makers. In the last few years, several states have debated small
business and entrepreneur-friendly tax policies including reduced rates on income earned Journal of Entrepreneurship and
Public Policy
Vol. 8 No. 4, 2019
pp. 523-548
© Emerald PublishingLimited
2045-2101
DOI 10.1108/JEPP-03-2019-0020
Received 19 March 2019
Revised 29 July 2019
30 July 2019
Accepted 30 July 2019
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/2045-2101.htm
JEL Classification —H2, H7, L26
The authors are grateful to Christine Kymn, John Deskins, Xiaowen Liu, Daniel Wilmoth and
Miriam Segal for assistance with the data and for helpful comments.
523
State tax and
expenditure
policies
by non-corporate “pass-through”entities (for which income passes through to the individual
owners and is taxed under the individual rather than the corporate income tax (CIT)) and
more general reductions in personal income tax (PIT) rates (Bruce et al., 2009; Bruce and
Deskins, 2012). The most extreme example came in 2012 when Kansas exempted pass-
through income from their state individual income tax (DeBacker et al., 2019). This same
logic has taken center-stage at the federal level, as the recently enacted Tax Cuts and Jobs
Act includes an exemption that effectively lowers the maximum marginal tax rate (MTR) on
pass-through income.
Research on tax policy and entrepreneurship has been explored with an equal amount of
interest. A significant amount of literature exists on the impacts ofboth state and federal tax
policy on entrepreneurship. Whilethe majority of this researchhas explored entrepreneurship
and state tax policy at the national level, the literature on entrepreneurship and state tax
policy has grownin recent years. The aim of this paper is to contributeto the body of research
on state tax policy and entrepreneurship by building on the research of Bruce et al. (2015) by
more carefully and appropriately accounting for the time series features of state-level
longitudinal data, extending the time period of analysis and (3) exploring additional
explanatory variables, specifically education expenditures at the state level.
Bruce et al. (2015) provided the first dynamic panel analysis of state taxes and
entrepreneurial activity. In an empirical literature that had focused primarily on fixed
effects regression analysis, they estimate dynamic panel regressions (AB and ABBB)
developed by Arellano and Bond (1991), Arellano and Bover (1995) and Blundell and Bond
(1998), which revealed the general instability of the primary finding that state taxes had
only limited effects on entrepreneurial performance. In the present paper, we focus on a
more inclusive evaluation of the dynamics of the relationship between taxes and
entrepreneurship and provide a battery of alternative estimations to surround the question
and arrive at more robust conclusions. Bruce et al. (2015) make the following case for a
dynamic estimation approach:
When considering entrepreneurial outcomes, it is important to account for the fact that outcomes in
the previous periods could inherently affect outcomes in the current time period. This inertia in
entrepreneurial activity […] may result from such things as incomplete labor mobility (or other
labor-market frictions) or clientele loyalty. In panel data settings, it is important to control for
entrepreneurial performance in previous periods because small firms that are successful today are
more likely to be successful in the future. State-level observations are thus potentially correlated
over time (Bruce et al., 2015, p. 805).
In the absence of a true exogenous variation such as a quasi-natural experiment, all dynamic
panel estimators must be considered in light of their limitations. Virtually all of them,
including the AB and ABBB (System GMM) estimators are highly sensitive to functional
form specifications including the nature of the dynamic process, how autocorrelation is
addressed, the number of lags of the dependent variable included and the choice of
instruments. Additionally, Bun and Windmeijer (2010) show that especially when the series
are highly persistent, and the variance of state effects are large relative to the transitory
shocks, even System GMM estimators can suffer from weak instrument problems. Finally,
estimates from dynamic panel estimators in this context should be interpreted with some
caution as these estimators are consistent but have less favorable finite sample properties.
In cases of state-level data (where N¼50), this is not a trivial concern.
While the evolution of state-level measures of entrepreneurship and tax rates are
inherently dynamic processes, no estimator in the available set of panel methods is strictly
preferable to all alternatives. We therefore examine thisrelationship using several estimators
and model specifications, each withtheir own limitations, to form ascomprehensive a picture
as possible of the effects of tax rates on entrepreneurship in the absence of a natural
experiment or perfect identification.
524
JEPP
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