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Testing the determinants of state business tax burdens
Testing the Determinants Business Tax Burdens
of State
Cynthia C. Vines, Charles W. Swenson and Waymond Rodgers
Political interest theory is used to derive predictions about cross-sectional and time-series variations in state tax burdens. We examine this variation in the context of interest group theory, positing that in states where business interest group strength is relatively significant, business tax rates are lower. The predictions are tested using total state business tax rates for the period 1973-1986. Employing theory similar to that used by Carpenter (1991), we find that state business tax rates are a function of political supply and demand factors. Such factors include legislative size, inter-party political competition, gubernatorial electoral competition, and business resources. Additionally, states’ total business tax rates were found to increase after the “tax revolution” (Gold 1984, p. 9) of 1978 when individual tax rates decreased.
1. Introduction Since the work of Due (19611, a number of studies have noted a large variation in state business tax rates, both cross-sectionally and over time; yet empirical evidence has failed to demonstrate why this variation occurs. The purpose of our study is to determine the extent to which political interest group theory (Peltzman 1976; McCormick and Tollison 1981) can explain such state business tax differentials. We examine these differentials in the context of interest group theory, positing that in states where business interest group strength is relatively significant, business tax rates are lower. In light of many states’ budget crises,’ additional insight into the determinants of tax revenues may be of significant practical importance. Address correspondence to Professor Cynthia C. H+l, University of Arizona, Tucson, AZ 85721. The states’ nationwide fiscal year 1992 budget corporate income tax (State Budget and Tax News, 1992, p. 3). The crisis had legislators in many states trying to avoid sharp cuts in current service spending The Issue II” 1992, p. 1). Journal of Accountmg
0
1994 Elsevier
Science
and Public Inc.
Policy,
13,205-224
Vines,
Department
of Accounting,
McClelland
shortfall was $2.5 billion or six percent of the “Revenues and Spending Closer to Estimates” attempting to maintain balanced budgets while levels (State Budget and Tax News, “Skirting
205
(1994) 0278.4254/94/$7.00
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Our analysis examines total business tax rates as part of entire state tax structures. In contrast, prior studies (e.g., Hunter and Nelson 1989; Anderson, et al. 1989; Salamon and Siegfried 1977) of the political determinants of business taxes have focused exclusively on separate components of total taxes (e.g., business taxes to the exclusion of individual taxes). To the extent that an increase in one type of tax can be used to offset a decrease in another, it is important to consider individual taxes as a factor which can affect business tax rates. Further, as noted by Hunter and Nelson (1989, p. 411, very little evidence has been gathered on overall state tax structures. In our study, variation in business tax rates is examined in the context of a comprehensive model of state tax structures over a fourteen year period. The time period examined, 1973-1986, is characterized by a high variation in tax rates. One significant cause of such variation was the so-called “tax revolution”* period after 1978, which was characterized by a number of tax rate or tax base limitations. Our results indicate that business tax rates are a function of political supply and political demand variables. Specifically, state business tax rates are a function of legislative size, inter-party political competition, gubernatorial election competition, and characteristics of the business community. More specifically, state business tax rates are positively related to the size of the state legislature, political competition, businesses’ political cost of organization, and individual taxpayer’s resistance to taxation. State business tax rates are negatively related to legislative single-party dominance, and businesses’ resources available for opposition mitigation. Our results further indicate a tradeoff between individual taxes which decreased and business taxes which increased after the “tax revolution” (Gold 1984, p. 9) of 1978. Our paper is organized as follows. In Section 2, state’ business tax burdens are defined and modelled via interest group theory. Results are presented in Section 3, and conclusions drawn in Section 4.
2. Business
Taxes and Interest Group Theory
2.1 Overview of Theory The basic premise of the economic interest group theory of government is as follows. Elected officials can be viewed as political entrepreneurs who broker wealth transfers among constituents. On the demand side of this brokering process, business may perceive that the marginal benefits of becoming politically informed and acting to influence legislation outweigh
‘Gold (1984, p, 9) dubbed the phenomenal blizzard of state tax cuts which followed the June 1978 passage of Proposition 13 in California as the “tax revolution.” Gold and Zelio (1989, p. 1505) showed that the downward trend in state individual taxes leveled off in 1983.
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associated marginal costs, i.e., they may lobby for and receive wealth transfers. On the other hand, individual voters remain rationally uninformed because the costs of changing political outcomes via voting exceed marginal benefits. From a supply perspective, the politician uses wealth transfers to facilitate election (or reelection), which in turn, provides wage compensation, consumption of non-pecuniary benefits, and outside wealth transfers. There are some frictions (discussed below), however, which may prevent the supply of wealth transfers in accordance with a politician’s wishes. Although the theory has been empirically supported at the state level on a variety of issues (c.f., McCormick and Tollison 1981), only Hunter and Nelson (1989, p. 571, Anderson et al. (1989, p. 141, and Salamon and Siegfried (1977, p. 1041) have examined state tax issues.3 Hunter and Nelson (1989, p. 57) reported that Louisiana property taxes were reduced by certain influential interest groups. In Anderson et al. (1989, p. 14) state sales taxes were found to be larger in states where lawmakers were themselves least subject to them, and individual voters least able to form interest groups to reduce them. Salamon and Siegfried (1977) examined the impact of influence groups on state gasoline excise tax rates across the states. They (1977, p. 1041) found that the stronger the petroleum industry in a given state (measured by size and concentration of firms within the industry), the smaller the gasoline excise tax in that state, or the more likely that state was to use the proceeds from the excise tax to improve state highways. In contrast to the above studies, we applied the interest group theory to total business tax rates. In determining business tax rates, we followed Wheaton (1983, p. 84) and divided the sum of total business taxes paid by business income for each state. Business taxes include corporate income, real and personal property (both state and local), unemployment payroll, severance, insurance premiums, stock and document transfer, public utility gross receipts, and business fees and licenses4
‘See Wang (1991) for a survey of applications to federal income taxes, and Siegfried (1981) for a coypilation of studies applying the theory to non-tax issues. Two limitations with respect to this measure relate to sales taxes and property taxes. As discussed in Wheaton (1983, p. 84), many states subject businesses to some sales taxes, but (because of various complex provisions) estimation of the business portion is difficult. Hence, sales taxes are not assumed here to be part of business taxes. As in Wheaton (1983, p. 84), two assumptions were made regarding property taxes. First, personal property taxes collected were assumed to be 75% business related. (Wheaton’s (1983, p. 84) limited telephone survey of states’ revenue departments provided estimates that approximately 75% of the personal property tax base is composed of industrial, commercial, or public utility property.) Second, reported local real property taxes were apportioned based on the ratio of industrial and commercial property values to total assessed valued in the state, as derived from Census of Governments (U.S. Bureau of the Census 1977, 1982, and 1987). With regard to both sales and property taxes, the above assumptions admittedly result in measurement error for the dependent variable, business tax rates. Measurement error in the dependent variable becomes incorporated in the disturbance term and causes no bias as long as the measurement error is not correlated with the independent variables (as assumed in our paper). The measurement error can increase the variance, thus lowering the power of our tests.
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Business taxes have been derived from U.S. (1989) and U.S. (1991) as well as earlier versions of these two publications. Business income is net value added accruing to the owners of businesses in each state, as reported in Renshaw et al. (1988, pp. 35-37).5 In economic terms, a state’s business income is the value of all outputs, less the value of all inputs (including labor but excluding taxes). In financial accounting terms, business income is similar (but not equal to) net income before taxes.6 As in the above-mentioned studies, we have included political demand, political supply, and fiscal factors in our analysis. In our model, business tax rates proxy for wealth transfers to business interest groups. As business interest groups become more powerful, demand for wealth transfers increases and business tax rates decrease. Supply of wealth transfers depends on the political environment. As political frictions within the political environment increase, wealth transfers decrease, leading to higher business tax rates. In this framework, business tax rates (BTR) are negatively related to the demand for wealth transfers and positively related to the supply of wealth transfers. Our empirical measures of these factors and their predicted relation to business tax rates are shown in Figure 1 and are discussed in the next sections.’
2.2 Political Demand According to Stigler (1971, p. 3) and Peltzman (1976, p. 2121, the lawmaker seeks to supply benefits to the business community as a whole at the * The lawmaker’s end objective is expense of individual voters/taxpayers. to maximize votes. One way to maximize votes is to provide benefits via lower taxes. Although businesses cannot vote, they are assumed to be capable of delivering votes through political influence. According to Peltzman’s (1976, p. 212) model, votes are a function of the following: the after-tax wealth of two adversarial groups; the number of potential taxpayers/voters in the beneficiary group; the probability that a beneficiary will grant support to the lawmaker; the total number of potential taxpayers/ voters, and the probability that those who are taxed (every non-beneficiary) opposes the tax. In our model, the two adversarial groups depicted in Peltzman’s (1976, p. 212) model are represented by the business community and individual
’ Details on the construction of this variable are given in U.S. (1984). 6 Calculated business taxes are available from the authors upon request. ‘Unless otherwise noted, data was derived from U.S. (1990) or Council of State Governments (19911, or earlier versions of these two publications. “As noted in Becker (1983, p. 372), most groups are both taxed and subsidized. Thus, in theory, business tax benefits given to one industry in a state could be accompanied by an equal tax increase on other businesses. However, it seems more plausible that offsetting tax increases are passed on to individuals who are unable to form effective interest groups to oppose such treatment.
Determining
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Figure 1. Relationships
Relationships
of Variables in Parentheses).
209
to Business Tax Rates. (Expected Signs of
taxpayers, respectively. The general model (1976, p. 212) predicts that members of both the beneficiary group and the taxed group will select to be rationally uninformed voters as long as the benefits of being informed are less than the transaction and information costs. Thus, we predict that businesses will organize to obtain favorable tax legislation as long as the tax benefits are greater than the campaign funding costs, lobbying costs, and cost of organizing the direct support of beneficiaries and mitigation of opposition’. Average business income of firms in a state (AVGBI) represents the resources available to pay for campaign funding, lobbying costs, and cost of opposition mitigation. As AVGBI increases, demand for wealth transfers to business increases resulting in lower business tax rates. As shown in Figure 1, a negative relation is hypothesized between BTR and AVGBI. The Peltzman (1976, p. 212) model assumes decreasing marginal political gain from the tax benefit, and strictly increasing political costs to taxation. In this characterization of the political process, the lawmakers/ candidates consider group size, the amount of the group’s expenditures to mitigate opposition, and the amount of wealth transfer when selecting the
‘Opposition is assumed generated by the tax increase and mitigated by voter education tures per capita. We note that Political Action Committee (PAC) and lobbying expenditures regularly collected by state and could not be included in our measure of firm expenditures.
expendiare not
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beneficiary group.” Organization costs (for both the group and the firm) increase with the size of the beneficiary group and therefore impose a further limit on the number of the beneficiary-group members. The number of firms in a state (FIRMS) serves as a surrogate for the beneficiary group size in the empirical model discussed in Section 3. If firms in a state band together for common tax benefits, their chances of success decline as the number of firms increases. Thus, the number of firms is a friction which decreases the demand for wealth transfers in the form of lower taxes. This argument implies a positive relation between FIRMS and BTR, as shown in Figure 1. The above discussion does not imply that politicians can pass additional taxes onto individuals with no limit. There are increasing costs to taxation in terms of voter dissatisfaction and increasing likelihood of loss of election (or reelection). That is, individuals have a demand for wealth transfers as well. In the empirical model presented in Figure 1, the demand by individuals for business taxation is captured in per capita income (PCY> and tax attitudes (TXATT).” As noted in Anderson et al. (1989, pp. ll-12>, per capita income has an indeterminate effect on business taxes. On one hand, individual wealth should result in an increase in tax collections from individuals as an increase in wealth implies an increase in taxable sales, property purchased, and taxable income. To the extent that individual tax collections increase, business taxes could be lowered fin a balanced budget setting) resulting in a negative relation between per capita personal income and business tax rates. On the other hand, high-income individuals may be able to form interest groups to reduce individual property taxes (Hunter and Nelson 1989, p. 42). If such tax reductions necessitate offsetting tax increases on the business sector, this results in a positive relation between business tax rates and per capita income. Tax attitudes (TXATT) were drawn from an annual regional survey of the Advisory Commission of Intergovernmental Relations (various years) and is the percent of respondents preferring a lower level of both individ-
“Firms, in turn, must decide how much to spend on organization costs, which increase with group size (Peltzman 1976, p. 215). Also, the firms work with the lawmakers/candidates in selecting the amount of opposition-mitigating expenditures. Thus, the firms’ problem (aggregated to the industry level as an interest group), is to maximize the wealth transfer minus the sum of all costs. While Peltzman does not explicitly model the firms’ side of the equilibrium with complete information and rational expectations, results using the politician’s decision-theoretic approach are similar to Becker’s (1983) game-theoretic approach (albeit not strictly comparable due to Becker’s focus on de$weight costs). Population was included as a political demand factor related to individual taxation. The coefficient estimate was negative (consistent with theory) but not statistically significant. However, it was highly collinear with most of the other explanatory variables, thus other coefficient estimates became unreliable (some coefficients switched signs). Accordingly, population was not included in the final regression models.
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ual taxes and services than those currently in place. This last variable is a measure of the voter tax resistance construct discussed in Peltzman (1976, p. 214). In states where resistance to higher individual tax rates is strong, lawmakers will find it more difficult (in a balanced budget setting) to provide wealth transfers to businesses through reduced business tax rates. This friction results in an expected positive relation between BTR and TXATT, as shown in Figure 1. Interest group dynamics are only one determinant of business tax rates. The next section discusses how the states’ political climates can facilitate or impede the supply of the demanded wealth transfers.
2.3 Political Supply Factors We have expanded the Peltzman model to include a political friction component as suggested by McCormick and Tollison (1981, pp. 29-52). A political friction is a characteristic of the political climate which slows or impedes legislation. For example, certain states might have inherent frictions (a large legislative size) or politically-induced friction (high political competition within the legislature resulting in non-cooperative behavior). As explained in the following paragraphs, these characteristics typically impede the politician’s ability to transfer wealth among constituents. We refer to these legislative frictions as political supply factors, noting that the Peltzman (1976, p. 227) factors are referred to above as political demand factors as the lawmaker is assumed to supply wealth transfers in response to political demands. In our model, an increase in supply implies an increase in wealth transfers resulting in lower business tax rates. However, as our measures are of supply frictions, increases in those frictions would result in a decrease in wealth transfers which would translate to an increase in business tax rates. Restated, as wealth transfers are mitigated by political frictions, business tax rates increase. The first political supply factor is the absolute size of the legislature for both the house and senate (THSSNT). Data for this variable was taken from Council of State Governments (1990). This variable is expected to affect business tax rates in three ways. As legislature size increases, the number of vote suppliers increases. Because politicians are brokers between winners and losers in the wealth transfer process, the degree of competition (as measured by number of legislative voters) in the legislative process will affect the cost of each legislator’s vote in much the same way that excess supply of any commodity drives down the price of that commodity. As the supply of votes increases, the marginal cost to the interest group of each individual vote decreases (McCormick and Tollison 1981, p. 33). A second effect of an increase in legislature size is the smaller relative
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influence of each individual legislator. Larger legislatures are characterized by relatively weak individual legislators as any one legislator is likely to have only a small impact on the wealth transfer to a special interest group (McCormick and Tollison 1981, p. 33). McCormick and Tollison (1981, p. 48) empirically documented this effect by finding that economic regulation was generally a decreasing function of legislature size. Thirdly, as the legislature size increases, it is more likely to represent the entire constituency and, thus, prevent a wealth transfer to special interest groups (McCormick and Tollison 1981, p. 34). McCormick and Tollison (1981, p. 40) anticipated that the second and third size effects would dwarf the first effect. In summary, we expect the aggregate size of House and Senate to be inversely related to wealth transfers to business as evidenced by high business tax rates (BTR). The second political supply factor shown in Figure 1 is ELECPCT, computed as one minus the percent of vote received by the winning candidate in the most recent gubernatorial election. As discussed in Carpenter (1991, p. ill), this is a measure of political competition. Figure 1 shows an expected inverse relation between business tax rates and ELECPCT, as competition for office would lead candidates to promise (and deliver) wealth transfers in the form of lower tax rates. The third political supply variable in Figure 1 is PRTYDOM, which is a dummy variable indicating either Democratic or Republican dominance of both the legislature and the governor’s office.” Based on arguments in Baber and Sen (1986, pp. 201-203), as a state’s inter-party political competition increases, business taxes decrease because legislators will not risk loss of reelection by increasing taxes. This implies that in states dominated by a single political party, observed tax rates will be higher, regardless of party affiliation. I3 Alternatively, Meier (1988, p. 141) noted that in a party-dominated state, interest groups need only ally themselves with the dominant political party. Non-special interest groups (individual taxpayers) are unlikely to have the political resources to overcome such an
” Democratic or Republican dominance is derived from Ranney’s (1976, pp. 85-86) measure of political competition. Ranney (1976, p. 86) averaged: 1) the percentage of popular vote won by Democratic gubernatorial candidates; 2) the percentage of state senate seats held by Democrat? 3) the percentage of the state house seats held by Democrats, and 4) the percentage of all terms for governor, senate, and house in which the Democrats had control. In this system, 0.5 represents absolutely even two-party competition. A measure from 0 to 0.5 represents Republican influence and a measure from 0.5 to 1 represents Democratic influence. Our measure consists of one dummy variable indicating dominance by either party. We also attempted to utilize Carpenter’s (1991, p. 113) measure of political competition, size of legislative staff. As this variable was collected (by survey) only in 1979 and 1988, our pre-1980 regressions included the first survey, and the 1980-1986 data included the average of 1979 and 1988. Due to the lack of variability in the data, this variable was never significant in the regressions. I3 This implicitly assumes that inter-party competition is dominant to intra-party competition in elections.
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alliance. In a competitive system, however, special interests must appeal to both political parties. Thus, the alternative conjecture is that nondominated states will be less responsive to special interest such as business. In the time period of our study (1973-19861, approximately 66% of the states (on average) were dominated by a single party.
2.4 Fiscal Constraints In addition to the political supply factors, fiscal factors can act as constraints on lawmakers’ ability to provide business tax burdens consistent with business demand. On the expenditures side, expenditures per capita (EXPPC) should be positively related to business tax rates as the higher the state’s expenditures, the more tax revenues (from all sources) are required to cover the expenditures. On the revenue side, federal grants per capita (FEDPC) and individual tax rates (INTR) should be negatively related to business tax rates as both are alternative sources of revenue.14 Individual tax rates were computed as total state taxes paid by individuals divided by total state personal income. Total individual taxes include income, property (apportioned-see footnote 41, estate and gift, and some user fees. Sales taxes were also included under the assumption that they are paid or ultimately borne by consumers (Anderson et al. 1989, p. 15).
3. Results 3.1 Structural Stability As noted in Anderson et al. (1989, p. lo>, interest group theory suggests an examination of the end result of public policies to determine policy goals. Here, interest group theory suggests that in states where low business tax rates are observed, business groups have been effective in obtaining favorable tax treatments. As theory does not suggest the time lags involved, we regressed current year tax rates against the preceding (or most recent) year explanatory variables. However, two of the budgetary control variables (EXPPC and FEDPC) were not lagged on the assumption that lawmakers have rational expectations as to these budgetary items. This
I4 Debt per capita may have an ambiguous effect on tax rates. If debt is used as a temporary substitute for taxes, there is a negative effect. A positive relationship would occur if a state’s borrowing is so large that it is precluded from going to the debt market, and must rely on tax financing. Another positive influence would occur to the extent to which taxes are used to pay for debt service. To test these conjectures, debt per capita was included in the regressions, but its correlation with federal grants per capita and expenditures per capita resulted in unstable models and unreliable results.
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assumption seems reasonable as the state budgeting process usually takes place in the prior year, allowing lawmakers to anticipate budgetary income and expenditures. In addition, once certain expenditure items are included in the state budget, the political process makes removal of the line item difficult, resulting in budgetary consistency from year to year. The proposed model is: BTR,,i
= f
FZ~St_l,l,
(-)
PCY,~,,i, (+ or -1
c-t>
THSSNT,_ I,, , ELECPCT,
FEDPC,,i> INTR,_l,i,e, c-1
c--j
(+I
_ , , , PRTYDOM, _ , , , EXPPC,, i, (+ or -> ’ ’ (+)
(+I
(+>
TXATT,~,,,,
(3.1)
i) ’
Estimation of the above model by ordinary least squares (OLS) regression across the time period 1973-1986, assumes that both the intercept and beta coefficients are constant across time. As mentioned in the introduction, this stability requirement may be violated due to the tax revolution which resulted in reduced individual tax rates starting with the June 1978 passage of Proposition 13 in California. To the extent that the tax revolution caused a disruption in the underlying relations of the model, a structural shift may have occurred which would cause parameter estimates to change over time. To examine this conjecture we conducted three analyses. First, we plotted average business and individual tax rates over time. As shown in Figure 2, individual rates appear to have decreased over time, while business rates which have a larger variance, tended to increase. A second indication of the structural shift was derived by performing Chow’s (1960, p. 599) F tests of regressions. We estimated equation (3.1) separately for each of three subperiods: 1973-1977; 1978-1982, and 1983-1986.‘j To test for a structural shift between any of these two time periods, observations across subperiods were pooled and residuals were compared to the residuals for regressions which allow the intercept and slope coefficients to vary across the two subperiods. The critical (tabled) and calculated F statistics for these tests are shown in Table 1. As can be seen, the calculated F statistics exceed the critical F statistics for the period 1973-1977 versus 1978-1986 indicating that the pooling across these years is not appropriate as there appears to be a structural shift after 1977. However, there was no similar shift between periods 1978-1982 and 1983-1986. Thus, if the tax revolution came to an end in 1982, it had no obvious effect on business tax rates. As a diagnostic check,
I5 The period 1983-1986 was tested as a separate individual taxes appeared to level off in 1983.
period
because
the downward
trend
in states’
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Tax Burdens
Averoge
Business
Taxes
23
171
, 1973
I 1977
1975 1974
1976
Average
I
I 1979 1978
Yeor
Individual
7.9
Figure 2
1981 1980
1983 1982
Taxes
1985 1984
1986
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Table 1. Tests of Structural 1973-1977 L’s 1978-1986: Calculated F Critical (tabled) F Conclusion: Structural 197X-1982 US 198331986: Calculated F Critical (tabled) F Conclusion: Structural 1973-1977 L‘S1978-1982: Calculated F Critical (tabled) F Conclusion: Structural ‘All
critical
(tabled)
Shifts” 2.61 1 SO
shift occurred
between
two time periods. 1.34 1.80
shift did not occur between
two time periods. 3.32 1 SO
shift occurred
statistics
between
are for two-tailed
two time periods.
Fll,r,,lS
Table 1 also reports Chow tests of structural shifts up to 1982. The reported F statistics corroborate the structural shift after 1977 due to the tax revolution. Accordingly, the 14 years of data were split into the pre- and post-tax revolution subperiods 1973-1977 and 1978-1986, respectively.‘+j Third, in Table 2, we compare means and standard deviations of tax rates as well as other variables for the two subperiods 1973-1977 and 1978-1986. Consistent with our expectations, business tax rates (BTR) increased after 1977 and individual tax rates (INTR) decreased slightly after 1977. Average individual tax rates for these two subperiods were 8.0 and 7.0, respectively. This difference in means is statistically significant at the .Ol level. Average business tax rates for the two subperiods were 18.0, and 21.0, respectively. Again, t-tests (two-tailed) of the difference in means
“WC used F tests to test whether either slopes or intercepts varied across the entire 14-year period (Maddala 1977, pp. 322-324). Results indicated that both slopes and intercepts did in fact change at some unspecified point(s) in time. The exact time of change was suggested by the taxpayer revolution conjecture, and the above F tests seemed to support this. In addition, to determine whether slopes and/or intercepts were constant across years within subperiods, we performed analysis of covariance within subperiods. The ANOCOVA results within subperiods were as follows: Test for equalityof intercepts Calculated F Critical F Test for equalityof slopes Calculated F Critical F
1973-1977
1978-1986
1.24 1.44
0.47 1.39
0.91 I .44
1.41 1.39
Note that the above F tests are two-tailed. As the results show, three-fourths of the tests did not disconfirm our specification of pooling years of data and utilizing a single intercept. The slopes test for 1978-1986 indicated that slopes may have slightly changed. However, if we go to the ,025 level of significance, the critical F is approximately 1.48, indicating no slope change.
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Table 2. Descriptive
217
Tax Burdens
Statistics’ 1978-1986
1973-1971 Variable
Mean
Std Dev.
Mean
Std Dev.
BTR AVGBI FIRMS PCY TXATT THSSNT ELECPCT PRTYDOM EXPPC FEDPC INTR
0.18 0.08 82219.24 10186.01 36.69 157.75 0.44 0.65 1.22 250.91 0.08
0.10 0.04 83581.77 1079.9 4.46 60.34 0.08 0.47 0.23 59.56 0.01
0.21 0.09 111632.71 10613.00 34.72 155.52 0.43 0.66 1.37 406.23 0.07
0.09 0.11 124330.00 1501.15 4.05 58.17 0.07 0.47 0.26 89.30 0.01
BTR = business tax rate (total business taxes divided by business income). AVGBI = average business income per firm. FIRMS = number of businesses. PCY = per capita income. TXATT = tax attitudes from survey (0 to 100%). THSSNT = total number of House and Senate members in state legislature. ELECPCT = 1 ~ the percent of vote received by the winner in the most recent gubernatorial general election. PRTYDOM = dummy variable indicating either a Democratic or Republican dominated state. EXPPC = per capita expenditures. FEDPC = federal grants per capita. INTR = individual tax rates. “All continuous data deflated using GNP implicit price deflator. EXPPC is expenditures (in millions) divided by population (in thousands).
indicated a statistically significant increase in business tax rates between the two periods at the .Ol level. Although these results should only be considered suggestive, they are consistent with our structural shift predictions. A striking fiscal phenomenon shown in Table 2 is the roughly ten-percent increase in real expenditures per capita (EXPPC) between the two subperiods, accompanied by an increase in federal grants per capita (FEDPC) of over fifty percent between the two subperiods.
3.2 Regression Results The ordinary least squares (OLS) estimates for the two subperiods are shown in Table 3. In each regression, errors were autocorrelated across years. Accordingly, standard errors were corrected for an AR(l). There was some correlation among the independent variables but the regressors were not collinear per the SAS collinearity diagnostics. As an alternative check, several regressions were run excluding some of the more correlated variables. Parameter estimates and t statistics were virtually unchanged
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Table 3. Ordinary Least Squares Regression Results For Overall Business Tax Rates” (t Statistics in Parentheses) Right-Hand Side Variable Intercept Political Demand Variables In FIRMS,_, In AVGBI,_, In PCY, , In TXA7T, , Political Supply Variables In THSSNT, _ , In ELECPCT, , PRTYDOM, , Control Variables In EXPPC, In FEDPC, In INTR,
R2
Predicted
Sign
(+) C-J (- or +) (+)
(+) (-) (-
or +)
(+) (-) (6)
1973-1977
1978-1986
13.8’) ( - 9.75)
I .03 ( - 0.57)
0.15 (4.62)** -0.99 (- 12.10)** 0.30 (2.04)* 0.35 (1.25)
0.12 (4.25)** -0.11 c-2.69)** - 0.47 ( - 2.58)* 0.346 (2.73)**
0.15 (1.76)** 0.30 (2.04)* - 0.23 ( - 3.44)*
0.35 (5.56)** 0.17 (1.88) ~ 0.21 ( -4.34j*
0.02 (I .20) 0.10 (0.83) 0.09 (0.65) 0.81
1.46 (0.88) - 0.32 ( - 2.59)** - 0.36 ( - 3.54)** 0.70
“All financial data dcflatcd using implicit price GNP deflator. Standard errors corrected for AR (I) autocorrelation. Coefficients and f statistics rounded to nearest hundredth. See Table 2 for variable definitions. Both regressions are significant at .OOl or better. *Significant at less than .OS (two-tailed) ** Significant at leas than .05 (one-tailed) ***Significant at less than .I0 (one-tailed)
from those reported in Table 3. We report correlations among the variables for each subperiod in Table 4. In addition, we tested all variables for normality. Distributions were improved by a log transformation resulting in a log-log model.” For the period 1973-1977, Table 3 shows that the number of firms in a state (FIRMS) was positive and significant, and average business income per firm (AVGBI) was negative and significant, consistent with predictions. Percentage of people preferring lower individual taxes (TXAm) had no effect, and per capita income (PCY) was positively related to business tax rates (BTR). The positive coefficient on PCY is consistent with the findings of Hunter and Nelson (1989, p. 56) that wealthy individuals may have been
“Nwmality was tested with the Bera-Jarquc technique suggested in Judge et al. (1988, p. 891). All variables except individual tax rates (INTR) failed the normality test. In addition, residuals from the linear models failed normality tests. The log-log model improved variable and residual skewness and kurtosis. The log-log model permits the coefficients to be interpreted as elasticities and allows for comparisons across indcpcndent variables. As a specification check, WC also ran the model without the log transformations. The rcgrcssion results were qualitatively similar to those reported in Table 3.
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able to keep their property taxes low during this subperiod resulting in an offsetting increase in business taxes. Of the political supply variables, both the total number of House and Senate members (THSSNT) and ELECPCT (1 - the percent of vote received by the winner in the most recent gubernatorial general election) showed a significant positive relation with BTR. The positive coefficient for THSSNT is consistent with predictions; however, the positive coefficient on ELECPCT is not. The positive coefficient on ELECPCT may be explained by Meier’s (1988, pp. 141-142) prediction that in a competitive political system, special interest groups need to ally themselves with all candidatevesulting in less resources being available to any single candidate. This reduces the likelihood of success of a supported candidate, which may translate to higher taxes for the business interest groups in states with increased competition. For the period 1973-1977, party dominated states (PRTYDOM) had a significant negative coefficient. In the log-linear specification, the coefficient on PRTYDOM translated into e-.” or 0.79% of the business tax rates of politically-competitive states. ” Stated differently, party-dominated states had approximately 21% lower business tax rates (BTR) than politically-competitive states. Thus, our results support Meier’s (1988, pp. 141-142) theory that special interest groups are more able to obtain wealth transfers when a single party has control. Moving to the period 1978-1986, all political demand variables-number of firms in a state (FIRMS), average business income per firm (AVGBI), per capita income (PCY), and tax attitudes (TXATT)--were significant with signs consistent with predictions. As individual and business. tax rates are inversely related, this, in turn, may imply a negative relation between PCY and BTR. The observed negative coefficient on PCY occurred because an increase in wealth to individuals translates into increased individual tax collections through taxable sales, property purchased, and income. Higher individual tax collections substitute for business taxes, leading to a negative coefficient on both PCY and individual tax rates (INTR). In the subperiod 1978-1986, TXATT became significant and positively related to business tax rates as predicted, lending further support for the tax revolution. Again, total House and Senate members (THSSNT) was positively related to business tax rates (BTR) and significant. Single-party dominated states (PRTYDOM) was again associated with lower BTR consistent with
‘s Note that as the other right-hand side variables (which are continuous) are already in log form, the signs on their coefficients need no special interpretation, and the coefficients can be used to indicate elasticities. Thus, for example, a positive 0.13 coefficient estimate on FIRMS implies that for each one-percent increase in the number of firms in the state (in the previous year), the state’s current business tax rates increase by 0.13%.
Determining
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Tax Burdens
221
Meier’s (1988 pp. 141-142) hypothesis. In both subperiods, results for ELECPCT were not consistent with predictions.” The consistent positive coefficient for ELECPCT (1 - the percent of votes received by the elected governor) indicates that competition for governor’s office led to higher business tax rates, or stated in the alternative, governors who received larger percentages of the vote tended to have lower business tax rates. This apparent non-response to political competition seems consistent with the “Leviathan” (Nelson 1986, p. 283) arguments whereby governors tax at whatever levels they deem necessary to fund expenditures. This result is also consistent with Meier’s (1988, p. 27) conjecture that competition leads to a government which is more responsive to the constituency as a whole. Per capita expenditures (EXPPC) was insignificant. Individual tax rates (INTR) and federal grants per capita (FEDPC) were both significant and negatively related to BTR consistent with predictions. These results indicate the substitutability of both federal grants and individual taxes with business taxes. The large coefficient in INTR (vis-a-vis the insignificant coefficient for the subperiod 1973-1977) implies the increased importance of individual taxes during the tax revolution period. This coefficient implies that for each one-percent increase in individual tax rates, business tax rates decreased by 0.36%. In summary, the regression results indicate that observed business tax rates are a function of political supply and demand factors as suggested by political interest theory. This result held for both subperiods examined, although the magnitude of the coefficients fluctuated by subperiod.
4. Conclusions
and Extensions
Our study documents a large cross-sectional and time-series difference in business average effective state tax rates, for the period 1973-1986. We have examined this variation in the context of interest group theory, positing that in states where business-interest-group strength is relatively significant, business tax rates are lower. Regression results, controlling for budgetary needs, individual tax rates, and political supply factors, are consistent with our hypotheses. 2o Additionally, we found that after the tax revolution of 1978, individual tax rate declines were associated with business tax rate increases. To the extent that similar political processes were followed in other state policy matters, our study also provides corroborative evidence on an emerging line of research on a positive
“To test whether the distribution characteristics may have had an effect on the regressions, we plotted a histogram. ELECPCT (in logs) had a nearly bell-shaped distribution. Similarly, skewness (k$osis) statistics for ELECPCT were - 1.95(5.15), respectively. Our study makes no attempt to explain business tax rates in terms of deserved versus undeserved tax breaks (or burdens). Undoubtedly, observed business tax rates (BTR) are some mixture of each.
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theory of governmental accounting and auditing choice (Evans and Patton 1987; Ingram 1984) and CPA licensing (Young 1991; Ayres et al. 1989). The limitations of our study include the inability to examine influence expenditures; the unavailability of micro firm or industry data, and the proxy nature of the variables employed. Yet, the results are consistent with theory using a broad cross-section of states and over a long time period. It will be interesting to see whether the theory continues to explain observed tax rates
as an increasing
number
of states
face
budgetary
crises
into
the
1990s. If the theory is robust, then any relative tax burden increases in response to such deficits should be in proportion to relative business
strength and individual taxpayer opposition to tax increases. In addition, our analysis essentially assumes that within-state (industry) variation in business tax rates was not of significant magnitude to mask between-state variation. To the extent that data on tax payments by industry and state becomes available, the within-state variation effect could be assessed in future research.
References Advisory Commission on Intergovernmental Relations. Public Attitudes on Gooernment and Taxes. Washington, sion on Intergovernmental Relations.
Various years. D.C.: Advisory
Changing Commis-
Anderson, G. M., Shughart, W. F., II, and Tollison, R. D. Jan. 1989. Political entry barriers and tax incidence: The political economy of sales and excise taxes. Public Finance 44(l):%17. Ayres, F. L., Jackson, B. R. and Hite, P. S. April 1989. The economic benefits of regulation: Evidence from professional tax preparers. The Accounting Review 64(2):300-312. Baber, W. R. and Sen, P. K. March 1986. The political process financing by state government. Public Choice 48(3):201-215. Becker, G. S. Aug. political influence. Carpenter, decision
and the use of debt
1983. A theory of competition among pressure Quarterly Journal of Economics 98(3):371-400.
V. L. Summer to adopt GAAP.
groups
for
1991. The influence of political competition on the Journal of Accounting and Public Policy 10(2X105-134.
Chow, G. C. July 1960. Tests of equality between regressions. Economettica 28(3):591-605. Council of State Governments. Works Pike.
sets of coefficients
in two linear
1990. The Book of the States. Lexington,
Due, J. F. June 1961. Studies of state-local National Tax Journal 14(2):163-173.
tax differences
on location
KY: Iron of industry.
Evans, J. H., III and Patton J. M. Supplement 1987. Signalling and monitoring public sector accounting. Journal of Accounting Research 2S(Suppl.):130-164. Gold, S. F. March 1984. State tax increases National Tax Journal 37X1):9-22.
of 1983: Prelude
to another
in
tax revolt?
Determining
State Business
223
Tax Burdens
Gold, S. F. and Zelio, J. March 20, 1989. Interstate tax comparisons have changed over time. Tax Notes 42(12):1501-1512. Hunter, W. J. and Nelson, M. A. July 1989. Interest Public Choice 62(1):41-61.
group
and how they
demand
for taxation.
Ingram, R. Spring 1984. Economic incentives and the choice of state government accounting practices. Journal of Accounting Research 220X126-144. Judge, G. G., Hill, R. C., Griffiths, W. E., Lutkepohl, H. and Lee, T. C. 1988. Introduction to the Theory and Practice of Econometrics (2nd Edition). New York: John Wiley & Sons. Maddala,
G. S. 1972. Econometrics. New York: McGraw
Hill.
McCormick, R. E. and Tollison, R. D. 1981. Politicians, Legislation, and the Economy: An Inquiry into the Interest Group Theory of Government. Boston: Martinus Nijhoff Publishing. Meier, K. J. 1988. The Political Economy of Regulation: The Case of Insurance. Albany, NY: State University of New York Press. Nelson, M. A. June 1986. An empirical analysis of state and local tax structure in the context of the leviathan model of government. Public Choice 49(3):283-294. Peltzman, S. Aug. 1976. Toward a more general Law and Economics 19(2):211-240.
theory
of regulation.
Journal of
Ranney, A. 1976. Parties in state politics. In Politics in the American States (H. Jacob and K. N. Vines, eds.) Boston: Brown. Renshaw, V., Trutt, C. A. and Reydenbero, M. L. May 1988. Gross state product industry, 1963-1986. Sumey of Current Business 68(5):30-46. Revenues and spending News. 11(11):3.
closer
to estimates.
by
May 21, 1992. State Budget and Tax
Salamon, L. M. and Siegfried, J. J. Sept. 1977. Economic power and political influence: The impact of industry structure on public policy. The American Political Science Review 71(3):1026-1043. Siegfried, J. J. 1981. The effects of conglomerate mergers and political mergers on political democracy: A survey. In The Conglomerate Corporation (D. Blain and R. F. Lanzillotti, eds.) Cambridge: Delgeschlager, Gunn & Main, pp. 2.5-52. Skirting the issue II, May 21, 1992. State Budget and Tax News. ll(ll):l. Stigler, G. J. Spring 1971. The theory of economic Economics and Management Science 2(1):2-21.
regulation.
Bell Journal of
United States (U.S.). 1990. Statistical Abstract of the United States. Washington, D.C.: U.S. Government Printing Office. United States (U.S.) Bureau of Census. 1991. Government Finances. Washington, D.C.: U.S. Government Printing Office. United States Washington,
(U.S.) Bureau of Census. 1989. State Government Tax Collection. D.C.: U.S. Government Printing Office.
United States (U.S.) Bureau of Economic Analysis. 1984. State Personal Income: Estimates for 1929-82 and a Statement of Sources and Methods. Atlanta, GA: U.S. Department of Commerce.
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Wang, S. W. Jan. 1991. The relation between firm size and effective tax rates: A test of firms’ political success. The Accounting Review 66(1):141-1.57. Wheaton, W. C. March 1983. Interstate differences taxation. National Tax Journal 36(1):83-94. Young, S. D. Oct. 1991. Interest group politics and accountants. The Accounting Reuiew 66(4):809-817.
in the
level
the
licensing
of business of public
of State
Cynthia C. Vines, Charles W. Swenson and Waymond Rodgers
Political interest theory is used to derive predictions about cross-sectional and time-series variations in state tax burdens. We examine this variation in the context of interest group theory, positing that in states where business interest group strength is relatively significant, business tax rates are lower. The predictions are tested using total state business tax rates for the period 1973-1986. Employing theory similar to that used by Carpenter (1991), we find that state business tax rates are a function of political supply and demand factors. Such factors include legislative size, inter-party political competition, gubernatorial electoral competition, and business resources. Additionally, states’ total business tax rates were found to increase after the “tax revolution” (Gold 1984, p. 9) of 1978 when individual tax rates decreased.
1. Introduction Since the work of Due (19611, a number of studies have noted a large variation in state business tax rates, both cross-sectionally and over time; yet empirical evidence has failed to demonstrate why this variation occurs. The purpose of our study is to determine the extent to which political interest group theory (Peltzman 1976; McCormick and Tollison 1981) can explain such state business tax differentials. We examine these differentials in the context of interest group theory, positing that in states where business interest group strength is relatively significant, business tax rates are lower. In light of many states’ budget crises,’ additional insight into the determinants of tax revenues may be of significant practical importance. Address correspondence to Professor Cynthia C. H+l, University of Arizona, Tucson, AZ 85721. The states’ nationwide fiscal year 1992 budget corporate income tax (State Budget and Tax News, 1992, p. 3). The crisis had legislators in many states trying to avoid sharp cuts in current service spending The Issue II” 1992, p. 1). Journal of Accountmg
0
1994 Elsevier
Science
and Public Inc.
Policy,
13,205-224
Vines,
Department
of Accounting,
McClelland
shortfall was $2.5 billion or six percent of the “Revenues and Spending Closer to Estimates” attempting to maintain balanced budgets while levels (State Budget and Tax News, “Skirting
205
(1994) 0278.4254/94/$7.00
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Our analysis examines total business tax rates as part of entire state tax structures. In contrast, prior studies (e.g., Hunter and Nelson 1989; Anderson, et al. 1989; Salamon and Siegfried 1977) of the political determinants of business taxes have focused exclusively on separate components of total taxes (e.g., business taxes to the exclusion of individual taxes). To the extent that an increase in one type of tax can be used to offset a decrease in another, it is important to consider individual taxes as a factor which can affect business tax rates. Further, as noted by Hunter and Nelson (1989, p. 411, very little evidence has been gathered on overall state tax structures. In our study, variation in business tax rates is examined in the context of a comprehensive model of state tax structures over a fourteen year period. The time period examined, 1973-1986, is characterized by a high variation in tax rates. One significant cause of such variation was the so-called “tax revolution”* period after 1978, which was characterized by a number of tax rate or tax base limitations. Our results indicate that business tax rates are a function of political supply and political demand variables. Specifically, state business tax rates are a function of legislative size, inter-party political competition, gubernatorial election competition, and characteristics of the business community. More specifically, state business tax rates are positively related to the size of the state legislature, political competition, businesses’ political cost of organization, and individual taxpayer’s resistance to taxation. State business tax rates are negatively related to legislative single-party dominance, and businesses’ resources available for opposition mitigation. Our results further indicate a tradeoff between individual taxes which decreased and business taxes which increased after the “tax revolution” (Gold 1984, p. 9) of 1978. Our paper is organized as follows. In Section 2, state’ business tax burdens are defined and modelled via interest group theory. Results are presented in Section 3, and conclusions drawn in Section 4.
2. Business
Taxes and Interest Group Theory
2.1 Overview of Theory The basic premise of the economic interest group theory of government is as follows. Elected officials can be viewed as political entrepreneurs who broker wealth transfers among constituents. On the demand side of this brokering process, business may perceive that the marginal benefits of becoming politically informed and acting to influence legislation outweigh
‘Gold (1984, p, 9) dubbed the phenomenal blizzard of state tax cuts which followed the June 1978 passage of Proposition 13 in California as the “tax revolution.” Gold and Zelio (1989, p. 1505) showed that the downward trend in state individual taxes leveled off in 1983.
Determining
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207
associated marginal costs, i.e., they may lobby for and receive wealth transfers. On the other hand, individual voters remain rationally uninformed because the costs of changing political outcomes via voting exceed marginal benefits. From a supply perspective, the politician uses wealth transfers to facilitate election (or reelection), which in turn, provides wage compensation, consumption of non-pecuniary benefits, and outside wealth transfers. There are some frictions (discussed below), however, which may prevent the supply of wealth transfers in accordance with a politician’s wishes. Although the theory has been empirically supported at the state level on a variety of issues (c.f., McCormick and Tollison 1981), only Hunter and Nelson (1989, p. 571, Anderson et al. (1989, p. 141, and Salamon and Siegfried (1977, p. 1041) have examined state tax issues.3 Hunter and Nelson (1989, p. 57) reported that Louisiana property taxes were reduced by certain influential interest groups. In Anderson et al. (1989, p. 14) state sales taxes were found to be larger in states where lawmakers were themselves least subject to them, and individual voters least able to form interest groups to reduce them. Salamon and Siegfried (1977) examined the impact of influence groups on state gasoline excise tax rates across the states. They (1977, p. 1041) found that the stronger the petroleum industry in a given state (measured by size and concentration of firms within the industry), the smaller the gasoline excise tax in that state, or the more likely that state was to use the proceeds from the excise tax to improve state highways. In contrast to the above studies, we applied the interest group theory to total business tax rates. In determining business tax rates, we followed Wheaton (1983, p. 84) and divided the sum of total business taxes paid by business income for each state. Business taxes include corporate income, real and personal property (both state and local), unemployment payroll, severance, insurance premiums, stock and document transfer, public utility gross receipts, and business fees and licenses4
‘See Wang (1991) for a survey of applications to federal income taxes, and Siegfried (1981) for a coypilation of studies applying the theory to non-tax issues. Two limitations with respect to this measure relate to sales taxes and property taxes. As discussed in Wheaton (1983, p. 84), many states subject businesses to some sales taxes, but (because of various complex provisions) estimation of the business portion is difficult. Hence, sales taxes are not assumed here to be part of business taxes. As in Wheaton (1983, p. 84), two assumptions were made regarding property taxes. First, personal property taxes collected were assumed to be 75% business related. (Wheaton’s (1983, p. 84) limited telephone survey of states’ revenue departments provided estimates that approximately 75% of the personal property tax base is composed of industrial, commercial, or public utility property.) Second, reported local real property taxes were apportioned based on the ratio of industrial and commercial property values to total assessed valued in the state, as derived from Census of Governments (U.S. Bureau of the Census 1977, 1982, and 1987). With regard to both sales and property taxes, the above assumptions admittedly result in measurement error for the dependent variable, business tax rates. Measurement error in the dependent variable becomes incorporated in the disturbance term and causes no bias as long as the measurement error is not correlated with the independent variables (as assumed in our paper). The measurement error can increase the variance, thus lowering the power of our tests.
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Business taxes have been derived from U.S. (1989) and U.S. (1991) as well as earlier versions of these two publications. Business income is net value added accruing to the owners of businesses in each state, as reported in Renshaw et al. (1988, pp. 35-37).5 In economic terms, a state’s business income is the value of all outputs, less the value of all inputs (including labor but excluding taxes). In financial accounting terms, business income is similar (but not equal to) net income before taxes.6 As in the above-mentioned studies, we have included political demand, political supply, and fiscal factors in our analysis. In our model, business tax rates proxy for wealth transfers to business interest groups. As business interest groups become more powerful, demand for wealth transfers increases and business tax rates decrease. Supply of wealth transfers depends on the political environment. As political frictions within the political environment increase, wealth transfers decrease, leading to higher business tax rates. In this framework, business tax rates (BTR) are negatively related to the demand for wealth transfers and positively related to the supply of wealth transfers. Our empirical measures of these factors and their predicted relation to business tax rates are shown in Figure 1 and are discussed in the next sections.’
2.2 Political Demand According to Stigler (1971, p. 3) and Peltzman (1976, p. 2121, the lawmaker seeks to supply benefits to the business community as a whole at the * The lawmaker’s end objective is expense of individual voters/taxpayers. to maximize votes. One way to maximize votes is to provide benefits via lower taxes. Although businesses cannot vote, they are assumed to be capable of delivering votes through political influence. According to Peltzman’s (1976, p. 212) model, votes are a function of the following: the after-tax wealth of two adversarial groups; the number of potential taxpayers/voters in the beneficiary group; the probability that a beneficiary will grant support to the lawmaker; the total number of potential taxpayers/ voters, and the probability that those who are taxed (every non-beneficiary) opposes the tax. In our model, the two adversarial groups depicted in Peltzman’s (1976, p. 212) model are represented by the business community and individual
’ Details on the construction of this variable are given in U.S. (1984). 6 Calculated business taxes are available from the authors upon request. ‘Unless otherwise noted, data was derived from U.S. (1990) or Council of State Governments (19911, or earlier versions of these two publications. “As noted in Becker (1983, p. 372), most groups are both taxed and subsidized. Thus, in theory, business tax benefits given to one industry in a state could be accompanied by an equal tax increase on other businesses. However, it seems more plausible that offsetting tax increases are passed on to individuals who are unable to form effective interest groups to oppose such treatment.
Determining
State Business Tax Burdens
Figure 1. Relationships
Relationships
of Variables in Parentheses).
209
to Business Tax Rates. (Expected Signs of
taxpayers, respectively. The general model (1976, p. 212) predicts that members of both the beneficiary group and the taxed group will select to be rationally uninformed voters as long as the benefits of being informed are less than the transaction and information costs. Thus, we predict that businesses will organize to obtain favorable tax legislation as long as the tax benefits are greater than the campaign funding costs, lobbying costs, and cost of organizing the direct support of beneficiaries and mitigation of opposition’. Average business income of firms in a state (AVGBI) represents the resources available to pay for campaign funding, lobbying costs, and cost of opposition mitigation. As AVGBI increases, demand for wealth transfers to business increases resulting in lower business tax rates. As shown in Figure 1, a negative relation is hypothesized between BTR and AVGBI. The Peltzman (1976, p. 212) model assumes decreasing marginal political gain from the tax benefit, and strictly increasing political costs to taxation. In this characterization of the political process, the lawmakers/ candidates consider group size, the amount of the group’s expenditures to mitigate opposition, and the amount of wealth transfer when selecting the
‘Opposition is assumed generated by the tax increase and mitigated by voter education tures per capita. We note that Political Action Committee (PAC) and lobbying expenditures regularly collected by state and could not be included in our measure of firm expenditures.
expendiare not
210
C. C. Vines et al.
beneficiary group.” Organization costs (for both the group and the firm) increase with the size of the beneficiary group and therefore impose a further limit on the number of the beneficiary-group members. The number of firms in a state (FIRMS) serves as a surrogate for the beneficiary group size in the empirical model discussed in Section 3. If firms in a state band together for common tax benefits, their chances of success decline as the number of firms increases. Thus, the number of firms is a friction which decreases the demand for wealth transfers in the form of lower taxes. This argument implies a positive relation between FIRMS and BTR, as shown in Figure 1. The above discussion does not imply that politicians can pass additional taxes onto individuals with no limit. There are increasing costs to taxation in terms of voter dissatisfaction and increasing likelihood of loss of election (or reelection). That is, individuals have a demand for wealth transfers as well. In the empirical model presented in Figure 1, the demand by individuals for business taxation is captured in per capita income (PCY> and tax attitudes (TXATT).” As noted in Anderson et al. (1989, pp. ll-12>, per capita income has an indeterminate effect on business taxes. On one hand, individual wealth should result in an increase in tax collections from individuals as an increase in wealth implies an increase in taxable sales, property purchased, and taxable income. To the extent that individual tax collections increase, business taxes could be lowered fin a balanced budget setting) resulting in a negative relation between per capita personal income and business tax rates. On the other hand, high-income individuals may be able to form interest groups to reduce individual property taxes (Hunter and Nelson 1989, p. 42). If such tax reductions necessitate offsetting tax increases on the business sector, this results in a positive relation between business tax rates and per capita income. Tax attitudes (TXATT) were drawn from an annual regional survey of the Advisory Commission of Intergovernmental Relations (various years) and is the percent of respondents preferring a lower level of both individ-
“Firms, in turn, must decide how much to spend on organization costs, which increase with group size (Peltzman 1976, p. 215). Also, the firms work with the lawmakers/candidates in selecting the amount of opposition-mitigating expenditures. Thus, the firms’ problem (aggregated to the industry level as an interest group), is to maximize the wealth transfer minus the sum of all costs. While Peltzman does not explicitly model the firms’ side of the equilibrium with complete information and rational expectations, results using the politician’s decision-theoretic approach are similar to Becker’s (1983) game-theoretic approach (albeit not strictly comparable due to Becker’s focus on de$weight costs). Population was included as a political demand factor related to individual taxation. The coefficient estimate was negative (consistent with theory) but not statistically significant. However, it was highly collinear with most of the other explanatory variables, thus other coefficient estimates became unreliable (some coefficients switched signs). Accordingly, population was not included in the final regression models.
Determining
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211
ual taxes and services than those currently in place. This last variable is a measure of the voter tax resistance construct discussed in Peltzman (1976, p. 214). In states where resistance to higher individual tax rates is strong, lawmakers will find it more difficult (in a balanced budget setting) to provide wealth transfers to businesses through reduced business tax rates. This friction results in an expected positive relation between BTR and TXATT, as shown in Figure 1. Interest group dynamics are only one determinant of business tax rates. The next section discusses how the states’ political climates can facilitate or impede the supply of the demanded wealth transfers.
2.3 Political Supply Factors We have expanded the Peltzman model to include a political friction component as suggested by McCormick and Tollison (1981, pp. 29-52). A political friction is a characteristic of the political climate which slows or impedes legislation. For example, certain states might have inherent frictions (a large legislative size) or politically-induced friction (high political competition within the legislature resulting in non-cooperative behavior). As explained in the following paragraphs, these characteristics typically impede the politician’s ability to transfer wealth among constituents. We refer to these legislative frictions as political supply factors, noting that the Peltzman (1976, p. 227) factors are referred to above as political demand factors as the lawmaker is assumed to supply wealth transfers in response to political demands. In our model, an increase in supply implies an increase in wealth transfers resulting in lower business tax rates. However, as our measures are of supply frictions, increases in those frictions would result in a decrease in wealth transfers which would translate to an increase in business tax rates. Restated, as wealth transfers are mitigated by political frictions, business tax rates increase. The first political supply factor is the absolute size of the legislature for both the house and senate (THSSNT). Data for this variable was taken from Council of State Governments (1990). This variable is expected to affect business tax rates in three ways. As legislature size increases, the number of vote suppliers increases. Because politicians are brokers between winners and losers in the wealth transfer process, the degree of competition (as measured by number of legislative voters) in the legislative process will affect the cost of each legislator’s vote in much the same way that excess supply of any commodity drives down the price of that commodity. As the supply of votes increases, the marginal cost to the interest group of each individual vote decreases (McCormick and Tollison 1981, p. 33). A second effect of an increase in legislature size is the smaller relative
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influence of each individual legislator. Larger legislatures are characterized by relatively weak individual legislators as any one legislator is likely to have only a small impact on the wealth transfer to a special interest group (McCormick and Tollison 1981, p. 33). McCormick and Tollison (1981, p. 48) empirically documented this effect by finding that economic regulation was generally a decreasing function of legislature size. Thirdly, as the legislature size increases, it is more likely to represent the entire constituency and, thus, prevent a wealth transfer to special interest groups (McCormick and Tollison 1981, p. 34). McCormick and Tollison (1981, p. 40) anticipated that the second and third size effects would dwarf the first effect. In summary, we expect the aggregate size of House and Senate to be inversely related to wealth transfers to business as evidenced by high business tax rates (BTR). The second political supply factor shown in Figure 1 is ELECPCT, computed as one minus the percent of vote received by the winning candidate in the most recent gubernatorial election. As discussed in Carpenter (1991, p. ill), this is a measure of political competition. Figure 1 shows an expected inverse relation between business tax rates and ELECPCT, as competition for office would lead candidates to promise (and deliver) wealth transfers in the form of lower tax rates. The third political supply variable in Figure 1 is PRTYDOM, which is a dummy variable indicating either Democratic or Republican dominance of both the legislature and the governor’s office.” Based on arguments in Baber and Sen (1986, pp. 201-203), as a state’s inter-party political competition increases, business taxes decrease because legislators will not risk loss of reelection by increasing taxes. This implies that in states dominated by a single political party, observed tax rates will be higher, regardless of party affiliation. I3 Alternatively, Meier (1988, p. 141) noted that in a party-dominated state, interest groups need only ally themselves with the dominant political party. Non-special interest groups (individual taxpayers) are unlikely to have the political resources to overcome such an
” Democratic or Republican dominance is derived from Ranney’s (1976, pp. 85-86) measure of political competition. Ranney (1976, p. 86) averaged: 1) the percentage of popular vote won by Democratic gubernatorial candidates; 2) the percentage of state senate seats held by Democrat? 3) the percentage of the state house seats held by Democrats, and 4) the percentage of all terms for governor, senate, and house in which the Democrats had control. In this system, 0.5 represents absolutely even two-party competition. A measure from 0 to 0.5 represents Republican influence and a measure from 0.5 to 1 represents Democratic influence. Our measure consists of one dummy variable indicating dominance by either party. We also attempted to utilize Carpenter’s (1991, p. 113) measure of political competition, size of legislative staff. As this variable was collected (by survey) only in 1979 and 1988, our pre-1980 regressions included the first survey, and the 1980-1986 data included the average of 1979 and 1988. Due to the lack of variability in the data, this variable was never significant in the regressions. I3 This implicitly assumes that inter-party competition is dominant to intra-party competition in elections.
Determining
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213
alliance. In a competitive system, however, special interests must appeal to both political parties. Thus, the alternative conjecture is that nondominated states will be less responsive to special interest such as business. In the time period of our study (1973-19861, approximately 66% of the states (on average) were dominated by a single party.
2.4 Fiscal Constraints In addition to the political supply factors, fiscal factors can act as constraints on lawmakers’ ability to provide business tax burdens consistent with business demand. On the expenditures side, expenditures per capita (EXPPC) should be positively related to business tax rates as the higher the state’s expenditures, the more tax revenues (from all sources) are required to cover the expenditures. On the revenue side, federal grants per capita (FEDPC) and individual tax rates (INTR) should be negatively related to business tax rates as both are alternative sources of revenue.14 Individual tax rates were computed as total state taxes paid by individuals divided by total state personal income. Total individual taxes include income, property (apportioned-see footnote 41, estate and gift, and some user fees. Sales taxes were also included under the assumption that they are paid or ultimately borne by consumers (Anderson et al. 1989, p. 15).
3. Results 3.1 Structural Stability As noted in Anderson et al. (1989, p. lo>, interest group theory suggests an examination of the end result of public policies to determine policy goals. Here, interest group theory suggests that in states where low business tax rates are observed, business groups have been effective in obtaining favorable tax treatments. As theory does not suggest the time lags involved, we regressed current year tax rates against the preceding (or most recent) year explanatory variables. However, two of the budgetary control variables (EXPPC and FEDPC) were not lagged on the assumption that lawmakers have rational expectations as to these budgetary items. This
I4 Debt per capita may have an ambiguous effect on tax rates. If debt is used as a temporary substitute for taxes, there is a negative effect. A positive relationship would occur if a state’s borrowing is so large that it is precluded from going to the debt market, and must rely on tax financing. Another positive influence would occur to the extent to which taxes are used to pay for debt service. To test these conjectures, debt per capita was included in the regressions, but its correlation with federal grants per capita and expenditures per capita resulted in unstable models and unreliable results.
214
C. C. Vines et al.
assumption seems reasonable as the state budgeting process usually takes place in the prior year, allowing lawmakers to anticipate budgetary income and expenditures. In addition, once certain expenditure items are included in the state budget, the political process makes removal of the line item difficult, resulting in budgetary consistency from year to year. The proposed model is: BTR,,i
= f
FZ~St_l,l,
(-)
PCY,~,,i, (+ or -1
c-t>
THSSNT,_ I,, , ELECPCT,
FEDPC,,i> INTR,_l,i,e, c-1
c--j
(+I
_ , , , PRTYDOM, _ , , , EXPPC,, i, (+ or -> ’ ’ (+)
(+I
(+>
TXATT,~,,,,
(3.1)
i) ’
Estimation of the above model by ordinary least squares (OLS) regression across the time period 1973-1986, assumes that both the intercept and beta coefficients are constant across time. As mentioned in the introduction, this stability requirement may be violated due to the tax revolution which resulted in reduced individual tax rates starting with the June 1978 passage of Proposition 13 in California. To the extent that the tax revolution caused a disruption in the underlying relations of the model, a structural shift may have occurred which would cause parameter estimates to change over time. To examine this conjecture we conducted three analyses. First, we plotted average business and individual tax rates over time. As shown in Figure 2, individual rates appear to have decreased over time, while business rates which have a larger variance, tended to increase. A second indication of the structural shift was derived by performing Chow’s (1960, p. 599) F tests of regressions. We estimated equation (3.1) separately for each of three subperiods: 1973-1977; 1978-1982, and 1983-1986.‘j To test for a structural shift between any of these two time periods, observations across subperiods were pooled and residuals were compared to the residuals for regressions which allow the intercept and slope coefficients to vary across the two subperiods. The critical (tabled) and calculated F statistics for these tests are shown in Table 1. As can be seen, the calculated F statistics exceed the critical F statistics for the period 1973-1977 versus 1978-1986 indicating that the pooling across these years is not appropriate as there appears to be a structural shift after 1977. However, there was no similar shift between periods 1978-1982 and 1983-1986. Thus, if the tax revolution came to an end in 1982, it had no obvious effect on business tax rates. As a diagnostic check,
I5 The period 1983-1986 was tested as a separate individual taxes appeared to level off in 1983.
period
because
the downward
trend
in states’
Determining
State Business
215
Tax Burdens
Averoge
Business
Taxes
23
171
, 1973
I 1977
1975 1974
1976
Average
I
I 1979 1978
Yeor
Individual
7.9
Figure 2
1981 1980
1983 1982
Taxes
1985 1984
1986
216
C. C. Vines et al.
Table 1. Tests of Structural 1973-1977 L’s 1978-1986: Calculated F Critical (tabled) F Conclusion: Structural 197X-1982 US 198331986: Calculated F Critical (tabled) F Conclusion: Structural 1973-1977 L‘S1978-1982: Calculated F Critical (tabled) F Conclusion: Structural ‘All
critical
(tabled)
Shifts” 2.61 1 SO
shift occurred
between
two time periods. 1.34 1.80
shift did not occur between
two time periods. 3.32 1 SO
shift occurred
statistics
between
are for two-tailed
two time periods.
Fll,r,,lS
Table 1 also reports Chow tests of structural shifts up to 1982. The reported F statistics corroborate the structural shift after 1977 due to the tax revolution. Accordingly, the 14 years of data were split into the pre- and post-tax revolution subperiods 1973-1977 and 1978-1986, respectively.‘+j Third, in Table 2, we compare means and standard deviations of tax rates as well as other variables for the two subperiods 1973-1977 and 1978-1986. Consistent with our expectations, business tax rates (BTR) increased after 1977 and individual tax rates (INTR) decreased slightly after 1977. Average individual tax rates for these two subperiods were 8.0 and 7.0, respectively. This difference in means is statistically significant at the .Ol level. Average business tax rates for the two subperiods were 18.0, and 21.0, respectively. Again, t-tests (two-tailed) of the difference in means
“WC used F tests to test whether either slopes or intercepts varied across the entire 14-year period (Maddala 1977, pp. 322-324). Results indicated that both slopes and intercepts did in fact change at some unspecified point(s) in time. The exact time of change was suggested by the taxpayer revolution conjecture, and the above F tests seemed to support this. In addition, to determine whether slopes and/or intercepts were constant across years within subperiods, we performed analysis of covariance within subperiods. The ANOCOVA results within subperiods were as follows: Test for equalityof intercepts Calculated F Critical F Test for equalityof slopes Calculated F Critical F
1973-1977
1978-1986
1.24 1.44
0.47 1.39
0.91 I .44
1.41 1.39
Note that the above F tests are two-tailed. As the results show, three-fourths of the tests did not disconfirm our specification of pooling years of data and utilizing a single intercept. The slopes test for 1978-1986 indicated that slopes may have slightly changed. However, if we go to the ,025 level of significance, the critical F is approximately 1.48, indicating no slope change.
Determining
State Business
Table 2. Descriptive
217
Tax Burdens
Statistics’ 1978-1986
1973-1971 Variable
Mean
Std Dev.
Mean
Std Dev.
BTR AVGBI FIRMS PCY TXATT THSSNT ELECPCT PRTYDOM EXPPC FEDPC INTR
0.18 0.08 82219.24 10186.01 36.69 157.75 0.44 0.65 1.22 250.91 0.08
0.10 0.04 83581.77 1079.9 4.46 60.34 0.08 0.47 0.23 59.56 0.01
0.21 0.09 111632.71 10613.00 34.72 155.52 0.43 0.66 1.37 406.23 0.07
0.09 0.11 124330.00 1501.15 4.05 58.17 0.07 0.47 0.26 89.30 0.01
BTR = business tax rate (total business taxes divided by business income). AVGBI = average business income per firm. FIRMS = number of businesses. PCY = per capita income. TXATT = tax attitudes from survey (0 to 100%). THSSNT = total number of House and Senate members in state legislature. ELECPCT = 1 ~ the percent of vote received by the winner in the most recent gubernatorial general election. PRTYDOM = dummy variable indicating either a Democratic or Republican dominated state. EXPPC = per capita expenditures. FEDPC = federal grants per capita. INTR = individual tax rates. “All continuous data deflated using GNP implicit price deflator. EXPPC is expenditures (in millions) divided by population (in thousands).
indicated a statistically significant increase in business tax rates between the two periods at the .Ol level. Although these results should only be considered suggestive, they are consistent with our structural shift predictions. A striking fiscal phenomenon shown in Table 2 is the roughly ten-percent increase in real expenditures per capita (EXPPC) between the two subperiods, accompanied by an increase in federal grants per capita (FEDPC) of over fifty percent between the two subperiods.
3.2 Regression Results The ordinary least squares (OLS) estimates for the two subperiods are shown in Table 3. In each regression, errors were autocorrelated across years. Accordingly, standard errors were corrected for an AR(l). There was some correlation among the independent variables but the regressors were not collinear per the SAS collinearity diagnostics. As an alternative check, several regressions were run excluding some of the more correlated variables. Parameter estimates and t statistics were virtually unchanged
218
C. C. Vines et al.
Table 3. Ordinary Least Squares Regression Results For Overall Business Tax Rates” (t Statistics in Parentheses) Right-Hand Side Variable Intercept Political Demand Variables In FIRMS,_, In AVGBI,_, In PCY, , In TXA7T, , Political Supply Variables In THSSNT, _ , In ELECPCT, , PRTYDOM, , Control Variables In EXPPC, In FEDPC, In INTR,
R2
Predicted
Sign
(+) C-J (- or +) (+)
(+) (-) (-
or +)
(+) (-) (6)
1973-1977
1978-1986
13.8’) ( - 9.75)
I .03 ( - 0.57)
0.15 (4.62)** -0.99 (- 12.10)** 0.30 (2.04)* 0.35 (1.25)
0.12 (4.25)** -0.11 c-2.69)** - 0.47 ( - 2.58)* 0.346 (2.73)**
0.15 (1.76)** 0.30 (2.04)* - 0.23 ( - 3.44)*
0.35 (5.56)** 0.17 (1.88) ~ 0.21 ( -4.34j*
0.02 (I .20) 0.10 (0.83) 0.09 (0.65) 0.81
1.46 (0.88) - 0.32 ( - 2.59)** - 0.36 ( - 3.54)** 0.70
“All financial data dcflatcd using implicit price GNP deflator. Standard errors corrected for AR (I) autocorrelation. Coefficients and f statistics rounded to nearest hundredth. See Table 2 for variable definitions. Both regressions are significant at .OOl or better. *Significant at less than .OS (two-tailed) ** Significant at leas than .05 (one-tailed) ***Significant at less than .I0 (one-tailed)
from those reported in Table 3. We report correlations among the variables for each subperiod in Table 4. In addition, we tested all variables for normality. Distributions were improved by a log transformation resulting in a log-log model.” For the period 1973-1977, Table 3 shows that the number of firms in a state (FIRMS) was positive and significant, and average business income per firm (AVGBI) was negative and significant, consistent with predictions. Percentage of people preferring lower individual taxes (TXAm) had no effect, and per capita income (PCY) was positively related to business tax rates (BTR). The positive coefficient on PCY is consistent with the findings of Hunter and Nelson (1989, p. 56) that wealthy individuals may have been
“Nwmality was tested with the Bera-Jarquc technique suggested in Judge et al. (1988, p. 891). All variables except individual tax rates (INTR) failed the normality test. In addition, residuals from the linear models failed normality tests. The log-log model improved variable and residual skewness and kurtosis. The log-log model permits the coefficients to be interpreted as elasticities and allows for comparisons across indcpcndent variables. As a specification check, WC also ran the model without the log transformations. The rcgrcssion results were qualitatively similar to those reported in Table 3.
Determining
State Business
Tax Burdens
219
220
C. C.
Vines et al.
able to keep their property taxes low during this subperiod resulting in an offsetting increase in business taxes. Of the political supply variables, both the total number of House and Senate members (THSSNT) and ELECPCT (1 - the percent of vote received by the winner in the most recent gubernatorial general election) showed a significant positive relation with BTR. The positive coefficient for THSSNT is consistent with predictions; however, the positive coefficient on ELECPCT is not. The positive coefficient on ELECPCT may be explained by Meier’s (1988, pp. 141-142) prediction that in a competitive political system, special interest groups need to ally themselves with all candidatevesulting in less resources being available to any single candidate. This reduces the likelihood of success of a supported candidate, which may translate to higher taxes for the business interest groups in states with increased competition. For the period 1973-1977, party dominated states (PRTYDOM) had a significant negative coefficient. In the log-linear specification, the coefficient on PRTYDOM translated into e-.” or 0.79% of the business tax rates of politically-competitive states. ” Stated differently, party-dominated states had approximately 21% lower business tax rates (BTR) than politically-competitive states. Thus, our results support Meier’s (1988, pp. 141-142) theory that special interest groups are more able to obtain wealth transfers when a single party has control. Moving to the period 1978-1986, all political demand variables-number of firms in a state (FIRMS), average business income per firm (AVGBI), per capita income (PCY), and tax attitudes (TXATT)--were significant with signs consistent with predictions. As individual and business. tax rates are inversely related, this, in turn, may imply a negative relation between PCY and BTR. The observed negative coefficient on PCY occurred because an increase in wealth to individuals translates into increased individual tax collections through taxable sales, property purchased, and income. Higher individual tax collections substitute for business taxes, leading to a negative coefficient on both PCY and individual tax rates (INTR). In the subperiod 1978-1986, TXATT became significant and positively related to business tax rates as predicted, lending further support for the tax revolution. Again, total House and Senate members (THSSNT) was positively related to business tax rates (BTR) and significant. Single-party dominated states (PRTYDOM) was again associated with lower BTR consistent with
‘s Note that as the other right-hand side variables (which are continuous) are already in log form, the signs on their coefficients need no special interpretation, and the coefficients can be used to indicate elasticities. Thus, for example, a positive 0.13 coefficient estimate on FIRMS implies that for each one-percent increase in the number of firms in the state (in the previous year), the state’s current business tax rates increase by 0.13%.
Determining
State Business
Tax Burdens
221
Meier’s (1988 pp. 141-142) hypothesis. In both subperiods, results for ELECPCT were not consistent with predictions.” The consistent positive coefficient for ELECPCT (1 - the percent of votes received by the elected governor) indicates that competition for governor’s office led to higher business tax rates, or stated in the alternative, governors who received larger percentages of the vote tended to have lower business tax rates. This apparent non-response to political competition seems consistent with the “Leviathan” (Nelson 1986, p. 283) arguments whereby governors tax at whatever levels they deem necessary to fund expenditures. This result is also consistent with Meier’s (1988, p. 27) conjecture that competition leads to a government which is more responsive to the constituency as a whole. Per capita expenditures (EXPPC) was insignificant. Individual tax rates (INTR) and federal grants per capita (FEDPC) were both significant and negatively related to BTR consistent with predictions. These results indicate the substitutability of both federal grants and individual taxes with business taxes. The large coefficient in INTR (vis-a-vis the insignificant coefficient for the subperiod 1973-1977) implies the increased importance of individual taxes during the tax revolution period. This coefficient implies that for each one-percent increase in individual tax rates, business tax rates decreased by 0.36%. In summary, the regression results indicate that observed business tax rates are a function of political supply and demand factors as suggested by political interest theory. This result held for both subperiods examined, although the magnitude of the coefficients fluctuated by subperiod.
4. Conclusions
and Extensions
Our study documents a large cross-sectional and time-series difference in business average effective state tax rates, for the period 1973-1986. We have examined this variation in the context of interest group theory, positing that in states where business-interest-group strength is relatively significant, business tax rates are lower. Regression results, controlling for budgetary needs, individual tax rates, and political supply factors, are consistent with our hypotheses. 2o Additionally, we found that after the tax revolution of 1978, individual tax rate declines were associated with business tax rate increases. To the extent that similar political processes were followed in other state policy matters, our study also provides corroborative evidence on an emerging line of research on a positive
“To test whether the distribution characteristics may have had an effect on the regressions, we plotted a histogram. ELECPCT (in logs) had a nearly bell-shaped distribution. Similarly, skewness (k$osis) statistics for ELECPCT were - 1.95(5.15), respectively. Our study makes no attempt to explain business tax rates in terms of deserved versus undeserved tax breaks (or burdens). Undoubtedly, observed business tax rates (BTR) are some mixture of each.
222
C. C. Vines et al.
theory of governmental accounting and auditing choice (Evans and Patton 1987; Ingram 1984) and CPA licensing (Young 1991; Ayres et al. 1989). The limitations of our study include the inability to examine influence expenditures; the unavailability of micro firm or industry data, and the proxy nature of the variables employed. Yet, the results are consistent with theory using a broad cross-section of states and over a long time period. It will be interesting to see whether the theory continues to explain observed tax rates
as an increasing
number
of states
face
budgetary
crises
into
the
1990s. If the theory is robust, then any relative tax burden increases in response to such deficits should be in proportion to relative business
strength and individual taxpayer opposition to tax increases. In addition, our analysis essentially assumes that within-state (industry) variation in business tax rates was not of significant magnitude to mask between-state variation. To the extent that data on tax payments by industry and state becomes available, the within-state variation effect could be assessed in future research.
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in the
level
the
licensing
of business of public