Comments on State Tax Policy and Entrepreneurship

1. Comments onState Tax Policy and Entrepreneurship by Donald Bruce, Xiaowen Liu and Matthew Murray Competition and Subnational Governments April 25, 2014

2. Brief Overview Very interesting, important question (and answer)– What effect does state tax policy have on entrepreneurial activity? Not much, apparently! Recent evidence suggests that state policymakers believe it is important as, for the first time, two states (Georgia & Michigan) have reduced their elderly income tax breaks (designed to attract retirees) while simultaneously increasing business tax breaks The paper makes 3 contributions to existing work: • Uses different (intensive-margin) measures of entrepreneurial activity • Includes a longer time period (1978-2009) • Explores the effects of estimating dynamic panel models as opposed to conventional fixed effects regression.

3. First set of suggestions – provide more background on the three contributions • Different measures of entrepreneurship = Nonfarm proprietors’ income (NFPI) and employment (NFPE). Each expressed 3 ways (per capita, as share of total state income & as share of national NFPI, NFPE). • Both capture extensive and intensive margins (# of entrepreneurs x income/employment) • How much do they differ from extensive measures? • What about income per proprietor (pure intensive)? • Second measure also captures labor intensity = could be differentially affected by corporate taxes (tax on k) • Both measures might be more affected by lagged taxes – last period’s tax policy could influence growth (intensive)more than sheer survival (extensive)

4. First set of suggestions (continued) • Including a longer time period (1978-2009) = e.g., Bruce & Deskins (2012) spans 1989-2002. • These added years contain critical state policy changes, including • TRA86 which corresponded to similar reforms at state level, reducing the top mtr’s of many state income tax systems • EGTRRA of 2001 which phased out the state estate tax credit (‘soak-up tax’) and led several states to effectively ‘bring back’ their estate and inheritance taxes • Adding these years may therefore provide substantially more variation in the key variables, which is necessary for identifying an effect • I would like to see more evidence of how much these policies actually changed, especially because of the dynamic panel model used. Lack of variation could explain lack of an effect. • State estate, inheritance and gift taxes changed a lot during this period and long time trend of reduction was reversed in the 2000s – should control for?

5. First set of suggestions (continued) • Exploring a dynamic panel model = including 1st and 2nd lags of Y and using Arellano-Bond/Bover estimators. • Would like to see more evidence/discussion of why this specification is justified. Figure 1 reveals strong time trends but there may be less data-intensive ways of dealing with it (e.g., state-specific time trends) • Seems likely that tax policies may also have a lagged effect and could explain observed inertia. What happens if lagged policies included? • You have a very long panel and thus a large number of instruments. Are the results robust to limiting the number of lags used as ivs? • Do you see any effect in simpler, descriptive analyses? Identify key changes in tax policy and look for effects before & after – graphically or with simple diff-in-diff.

6. The Channels for Change Where is the change in entrepreneurship coming from? Several possible channels: • Switch between wage and self-employed (emphasized by share of all income measure) • Switch caused by relocating across state lines (emphasized by share of national NFPI) • Switch between idle (unemployed) and self-employed =implied by positive effect of unemployment rate • Factors affecting, implications of the change likely differ between the 3 channels • The size of entrepreneurial activity (numerator in all 3 measures) are a function of all 3 channels

7. Channels for change -- continued 2nd channel (switch locations) suggests including the policies of each state’s chief ‘competitors’ • Could be bordering states, states with high historic interstate migration or similar resources/markets • Omission could explain lack of results • Implies a zero sum game and race to the bottom • Should be most important in the regressions using share of national NFP measures • Might be able to measure this channel directly via migration of those reporting business income in census

8. Channels for change -- continued The other two channels (switching from another employment status) seem to be more what the model (X’s) are capturing. Still raised some ‘big picture’ questions for me: • Is it clear that switching from wage to entrepreneurial activities is beneficial for the state? (both are presumably productive and the latter should create the former, right?) • A naïve interpretation of your results is that a high unemployment rate is ‘good’ – if one wants to increase entrepreneurship. • Suggests that the analyses may be incomplete in measuring the desirable features of entrepreneurial activity.

9. More minor comments, suggestions Key Table -- Comparison of Models (Table 6): • Bruce & Deskins (1st column) doesn’t match discussion in intro (not significant, no estate taxes). Are these the actual results they report? Is the difference due to using the employment measure? Are estate taxes included? • More informative column headings would help – tough for this reader to follow the comparisons • Standard errors would be helpful for finer comparisons • All ‘intermediate’ models, including the ‘simple replication,’ find at least one policy is significant – in contrast to the 2 extremes. • Any explanation for why including all these changes would produce the most similar results to past work?

10. Minor comments, possible future directions • Is this relationship stable over such a long period of time? Test for a structural break? • Are the results robust to omitting 2008-9 (the Great Recession)? Alaska and/or Hawaii? • Other factors to consider • Types of government expenditures (as you acknowledge) = infrastructure versus transfers versus other? • Recent speculation of how ‘safety net’ programs allow employers to pay workers low wages – what are the effects on entrepreneurship? • Lots of action in health insurance policies during this time period – growth of Medicaid & SCHIP, state-level mandates. Maybe throw out (or study closely) MA post-2006? • Obtaining health insurance a likely obstacle to becoming self-employed • EITC = state-level EITCs changed during this period and could cause both real and reported changes in income

11. In Sum… • Very interesting question and one for which the answer is important, as state policymakers search for ways to promote growth through their tax codes. • Finding ‘no result’ of state tax policy is both plausible and important. Just need to • verify that it’s not due to the ‘usual suspects’ (e.g., low variation/statistical power, omitted variables) • establish how these measures capture the desirability of entrepreneurial activity to the state