Who benefits from state corporate tax cuts?

Here is a new VOXEU summary of my job market paper for their job market paper series:

State and local governments have been increasing business location incentives and cutting corporate taxes to attract businesses to their jurisdictions. For instance, Jay Inslee, the Gov. of Washington, recently passed a $9 billion corporate tax package for Boeing to retain its manufacturing base near Seattle. It is the largest corporate tax break any state has ever granted a company. The rising prevalence of these location-based incentives underscores the importance of revisiting the conventional wisdom of how corporate tax policy in an open economy affects the welfare of workers, firm owners, and landowners.

In the standard open economy framework of corporate tax incidence, immobile workers bear the full incidence of corporate taxes as capital flees high tax locations (Kotlikoff and Summers 1987, Gordon and Hines 2002). As a result, the conventional wisdom among economists and policymakers is that corporate taxation in an open economy is unattractive on both efficiency and equity grounds; it distorts the location and scale of economic activity and falls on the shoulders of workers. According to this standard view, firm owners cannot bear the incidence of business taxes or subsidies by assumption since they own identical, perfectly competitive firms with productivity that is independent of location.

Numerous empirical complications make assessing this view hard in practice (Auerbach 2006, Gravelle 2011, Clausing 2013). Moreover, even an ideal empirical implementation of the standard incidence models, as well as standard locational models (e.g., Roback 1982), would not be able to assess whether firm owners or workers benefit from these location-based incentives.

In recent research, co-authored with Juan Carlos Suárez Serrato, we provide a new framework in which firm owners can bear the incidence of local tax changes (Suárez Serrato and Zidar 2013).

  • We exploit changes in state tax rates and apportionment formulae to quantify the welfare effects of cutting corporate taxes on firm owners, workers, and landowners.
  • We find that firm owners enjoy roughly 40% of the total benefits of state corporate tax cuts, while workers and landowners get the remaining 35% and 25%, respectively.

These results have wide-ranging implications for the equity and efficiency consequences of corporate taxation, revenue-maximising corporate tax rates, and the design of corporate tax policy.

New evidence on business location and corporate taxation

Cutting corporate taxes increases the attractiveness of locating in a given state. While this margin of adjustment has been the focus of previous studies (e.g. Goolsbee and Maydew 2000), our new framework shows that the responsiveness of business location decisions to tax changes is a central ingredient in determining the incidence of corporate taxes. We use a new measure of the tax rates that businesses pay at the local level to estimate this crucial parameter. Our measure of tax changes uses firm-specific rates that we construct in Cullen et al. (2013) to form a county-group average business tax rate.

  • The variation comes from changes to state corporate tax rates and apportionment rules, which are state-specific rules that govern how national profits of multi-state firms are allocated for tax purposes.
  • We find that a 1% cut in local business taxes increases the number of local establishments by 3 to 4% over a ten-year period.

Our research demonstrates the robustness of these results through a series of tests.

New framework of business location and local labour demand

While this estimate is novel and important, it doesn’t directly answer the incidence question, so we build a framework to interpret it and to quantify the welfare effects of cutting corporate taxes. This model expands the state of the art frameworks in this literature (e.g. Kline and Moretti 2014) by modelling firms’ location and scale decisions, incorporating the possibility that individual firms have location-specific productivities, and deriving a simple expression that relates these features to local labour demand.

  • To the best of our knowledge, this framework is the first in the literature to allow firm owners to bear the incidence of local economic development policies.
  • It can be used to study a wide range of questions, such as optimal business location subsidies, the incidence of productivity shocks, the efficiency gains from cutting income or sales taxes, and place-based policies that focus on firms and local labour demand.

In our setting with mobile workers, firms, and capital, we allow for several margins of adjustment. Wages and housing prices can change, and firm prices and profits can change. We don’t observe the prices and profits of every business in the US, so we use the assumption that firms maximise profits to map things we can’t see – prices and profits – into four observable things we can see: how responsive establishment location, worker location, wages, and housing costs are to business tax changes.

Using these four observables, we recover the structural parameters that govern who benefits from corporate taxes. Recovering these parameters enables us to quantity the welfare effects of cutting corporate taxes and to run policy experiments and evaluate tax reforms.

New assessment of corporate tax incidence in an open economy

Our main result is that firm owners bear a substantial portion of the incidence of state corporate tax changes. The intuition for this result is that non-tax considerations, namely heterogeneous productivity, can limit the mobility of businesses. If a business is especially productive in a given location, small changes in taxes won’t have large enough impacts on profitability to make changing locations attractive. For instance, technology firms may still find it optimal to locate in Silicon Valley, even if corporate tax rates were increased modestly. Consequently, firm owners bear a substantial portion of the incidence of state corporate tax changes. This result starkly contrasts with the conventional wisdom, and that has important implications for the efficiency and equity effects induced by changes in corporate taxation rates.


Auerbach, A (2006), “Who Bears the Corporate Tax? A Review of What We Know,” in J Poterba (ed.), Tax Policy and the Economy, Vol. 20, The MIT Press, pp. 1–40.

Clausing, K (2013), “Who Pays the Corporate Tax in a Global Economy?” National Tax Journal, 66(1), pp. 151-184.

Cullen, Z, J C Suárez Serrato and O Zidar (2013), “State Corporate Taxes, Firm Mobility, and Innovation Productivity: Evidence from US patent data,” working paper, Stanford and UC Berkeley.

Goolsbee, A and E L Maydew (2000). “Coveting thy neighbour’s manufacturing: the dilemma of state income apportionment,” Journal of Public Economics, 75 (1), pp. 125 – 143.

Gordon, R and J Hines (2002), “International Taxation,” in A J Auerbach and M Feldstein (eds),Handbook of Public Economics, Vol. 4, Elsevier, pp. 1935 – 1995.

Gravelle, J (2011), “Corporate Tax Incidence: A Review of Empirical Estimates and Analysis, ” CBO working paper.

Kline, P and E Moretti (2014), “People, Places, and Public Policy: Some Simple Welfare Economics of Local Economic Development Programs,” Annual Review of Economics, forthcoming.

Kotlikoff, L and L Summers (1987). “Tax Incidence,” in A J Auerbach and M Feldstein (eds),Handbook of Public Economics, Vol. 2, Elsevier, Chapter 16.

Moretti, E (2011), “Local Labor Markets,” in O Ashenfelter and D Card (eds), Handbook of Labor Economics, Vol. 4, Elsevier, Chapter 14, pp. 1237–1313.

Roback, J (1982), “Wages, Rents, and the Quality of Life,” Journal of Political Economy 90 (6), pp. 1257–78.

Suárez Serrato, J C and O Zidar (2013), “Who Benefits from State Corporate Tax Cuts? A Local Labor Markets Approach with Heterogeneous Firms” UC Berkeley job market paper.

About ozidar

I'm an Assistant Professor of Economics at the University of Chicago Booth School of Business and a Faculty Research Fellow at National Bureau of Economic Research. You can follow me on twitter @omzidar. http://faculty.chicagobooth.edu/owen.zidar/index.html
This entry was posted in Uncategorized and tagged , , , , . Bookmark the permalink.

2 Responses to Who benefits from state corporate tax cuts?

  1. Ted Boettner says:

    “We find that a 1% cut in local business taxes increases the number of local establishments by 3 to 4% over a ten-year period”
    I find this very difficult to believe in the real world. State and local taxes make up a very small share of business expenses – usually no more than 2-3% unless the company is in the energy industry. (And a coal, oil, or gas company is very immobile to tax changes because the raw materials cannot be moved to a new location.) For example, according to the IRS Corporate Source Book, total business expenses in the U.S were about $25 trillion in 2010. Of this amount, businesses deducted about $493 billion in federal, state, and local taxes. This amounts to just two percent of total business expenses in 2010. Using a slightly higher figure of $619 billion provided by the Council on State Taxation (COST), state and local taxes paid by businesses equated to about 2.5 percent of business expenses in 2010 (and this includes severance taxes). 1% of this amount would be 0.25% of total business costs. I do not any business firm that would be induced by such a small amount.

  2. Ted Boettner says:

    Another thing to consider, is that most new (and large) firms that decide locate or expand in states pay very little in state and local taxes. Usually, they work out deals with the legislature and local economic development authorities so they never pay much. Here is a real world example: http://www.wvpolicy.org/gestamp-deal-worth-estimated-84-4-million

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s