ON THE IMPACT OF A SINGLE SALES FACTOR ON CALIFORNIA JOBS AND ECONOMIC GROWTH

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1 Doc pgs ON THE IMPACT OF A SINGE SAES FACTOR ON CAIFORNIA JOBS AND ECONOMIC GROWTH Chrles W. Senson, Ph.D., CPA Professor nd eventhl Reserch Fello Mrshll School of Busness Unversty of Southern Clforn os Angeles, CA June, 00.

2 Doc pgs Executve Sury The purpose of ths study s to estte the potentl pct to the stte of Clforn by stchng to Sngle Sles Fctor SSF for stte corporte ncoe tx purposes. Ths report predcts tht such stch to the SSF ll: Stulte busness nd ndustrl groth n the stte s esured by ncresed eployent; Help ttrct busness nto the stte; Help retn nd expnd busness nd ndustry; nd Crete ncresed job opportuntes for ll Clfornns To ost effcently nd effectvely ddress those objectves, ths study frst esttes the eployent nd sles effects on fve sttes hch recently stched to SSF. Usng the esttes or preters fro studyng these fve sttes, the study then predcts ht such slr effects ould be n Clforn, nd esttes the net tx revenue effects to Clforn fro such stch. Ths net tx revenue effect ncludes the loss of corporte ncoe tx revenues, offset by the ncrese n other txes. Ths study esttes tht the stch to SSF could, n the long run, crete pproxtely 44,000 pernent jobs n equlbru nd result n n nnul net revenue gn of $4 llon to the stte. The report tht follos provdes detled nforton derved fro the ntensve study conducted for ths progr. Whle no predctve study cn cl to be prescent, the results nd relted predctons re ethodologclly sound nd follo fro plusble fndngs. The nforton contned n ths report s both ccurte nd relevnt to help deterne the overll vlue of Clforn s stchng to n SSF ethod of pportonent.

3 Doc pgs Introducton Recent legslton llos Clforn ultstte txpyers stch to sngle sles fctor SSF pportonent strtng n 0. Brefly, SSF llos fr to pporton ts busness ncoe nto Clforn bsed solely on the rto of ts sles n Clforn to ts totl sles. Currently, Clforn eploys three fctor pportonent forul, bsed on the reltve rtos of Clforn versus totl property, pyroll, nd sles, here the sles fctor ccounts for 50% of the eght used n ths pportonent forul. Snce sngle sles fctor ould gve no eght to property nd pyroll, t s dely beleved to be n ncentve for fr to locte or expnd ts fcltes n the stte snce there ould be no ncoe tx cost of dong so. Understndng ths ncentve effect, nuerous sttes hve grdully stched fro property, pyroll nd sngle sles-eghted tx fctors to double-eghted sles fctors. More recently nuber of sttes ncludng Georg, ousn, Ne York, Oregon, nd Wsconsn hve stched fro double eghted sles fctors to SSF 3. But hve such sttes experenced the econoc groth hoped for by such stch? In short, they hve; on verge n equlbru, hundreds of thousnds of jobs pper to hve been creted. Ths study uses the results fro these fve sttes s benchrk to predct ht slr econoc gns ould be to Clforn n ters of job groth, nd fnds tht such groth could be potentl pernent ncrese of 44,000 jobs n the next to yers. An portnt consderton n the dopton of SSF s lso ts effect on the stte s tx revenues, especlly n lght of predcted $0 bllon defct n 00. Here, ths study predcts tht, fter tkng ccount of drect costs to the stte fro lost corporte ncoe txes, nd lso ncresed personl nd busness txes fro busness expnson, the stte could ctully gn $4 llon n net tx revenues nnully, n the next fe yers. Methodology In exnng econoc pcts of ny progr, hvng the ost ccurte nd detled dt s crtcl. Ths study utlzes the NETS Ntonl Estblshent Te Seres dtbse hch contns enterprse level dt for ll frs n every stte fro 990 to 008, nd s derved fro Dun & Brdstreet survey dt. The dt llos exnton of locton-specfc sles nd eployent by fr, ndustry ebershp, nd other ttrbutes. Also, the dt llos for dstngushng beteen frs tht ll be ffected by SSF frs hch hve ult-stte sles versus those hch do not. Ths ltter dstncton llos the creton of tretent versus control groups of frs fter the enctent of n SSF. Such bfurcton llos the controllng for fctors other thn the SSF hch ght ffect hether fr oves nto stte fter the SSF s encted, or hether t expnds ts opertons fter the SSF enctent. Predcted Ipct of the SSF on Clforn Frst, the study exnes the pct to stchng to SSF by other sttes. Ths s not trvl exercse; lthough sple econoc ntuton corroborted by rgorous econoc theory, s Clforn Revenue nd Txton Secton See chrt n Chpter 3 of Gupt, Senson, et l, Stte Txton: Prncples nd Plnnng 003. JRoss Publshng 3 Ths represents n ncresng trend tord SSF; 4 of the 46 sttes th ncoe txes hve SSF, nd nother 0 sttes llo SSF for certn ndustres. 3

4 Doc pgs shon n the Techncl Pper n the Appendx predcts tht such stch should nduce ddtonl groth nto stte, yet fe studes hve exned hether ths s n fct the cse. Econoc groth n SSF sttes fter controllng for non-ssf fctors ght not occur f frs do not rect to the l chnge due to trnscton costs of ovng/expndng, uncertnty s to hether such l chnges ll be pernent, etc. Fortuntely, nuber of nturl experents to test hether stchng to SSF s effectve exst. In 006, fve sttes Georg, ousn, Ne York, Oregon, nd Wsconsn stched to SSF. Testng the pct of SSF on these sttes provdes robust results due to the de vrety of sttes nd frs hch operte thn the. Usng the NETS dtbse for ll frs n these sttes fro 003 through 008, ths study esttes tht the SSF ncresed stte-de eployent on verge by pproxtely.83% 4 thn to yers. The ethodology eployed controls for trends by usng dfferences n dfferences estton ethod, nd exnes control group of frs hch ere not ffected by the SSF. The Tble belo shos eployent effects for these sttes. Tble Estted To Yer Eployent Chnges n Sttes Recently Adoptng SSF Stte Totl Nuber of Fr octons / Nuber of Fr octons Affected by SSF Georg,8,78 / 3,09 ousn 53,386 /,7 Ne York,433,79/ 4,860 Oregon 538,3 /,474 Wsconsn 60,397 /,796 Increse n Eployent Usng Regresson Coeffcents 30,49 5,330 04,58 9,554,03 Usng preter esttes fro econoetrc odels see Techncl Pper n the Appendx, ths study forecsts potentl eployent effects for Clforn usng NETS dt for Clforn for the frs ffected by the SSF. Ths result s pernent ncrese.e., n equlbru of 34,000 jobs 5. A coprson estton ethod, usng chnges n verge sttes eployents, s 54,000 jobs ths ethod y slghtly overstte snce t eqully eghts stte preters. Tkng the verge of these to esttes yelds n estted 44,000 Clforn jobs. It s portnt to note, hoever, tht the foreentoned job groth predctons re conservtve n the sense tht they do not drectly consder Type II ultpler effects. Whle the bove predcted job groth sttstcs re prosng, they ould be untenble f they resulted n net revenue loss to the stte. The FTB hs estted the drect costs of SSF 4 Snce Ne York nd Wsconsn ctully lost jobs on stte-de bss durng ths te, the bove fgures for these to sttes should be veed s jobs retned. 5 There ere,649,650 people eployed n SSF-ffected frs n Clforn s of 008 derved fro the NETS dt, hch ere relted to seprte 4,304 corportons hvng totl of over 5,300 loctons. These corportons generted $ bllon n revenues fro ther Clforn loctons. 4

5 Doc pgs dopton, n ters of lost Clforn corporte frnchse nd ncoe txes, t $800 llon nnully. Usng sles groth fro econoetrc odels for the bove fve sttes see tbles n the Techncl Pper n the Appendx, ths study s ble to estte predcted sles groth due to busness expnson, hch s then ultpled by ndustry proft rtos fro Clforn Frnchse Tx Bord publctons, nd then ultpled by the verge effectve busness tx rte for Clforn see Senson, 005; revsed 00, cted n the Appendx to obtn estted gns n busness txes to the Stte 6. These esttes re reported n the top hlf of Tble. Slrly, usng predcted eployent groth n Clforn due to the SSF fro regresson coeffcents, nd verge stte txes pd by ndvduls, the study esttes gns n personl txes pd by ndvduls to the Stte. Ths ltter estte s shon n the loer hlf of Tble. Tble Estted Annul Increse n Clforn Tx Collectons Fro Adoptng SSF Chnge n Busness Tx Collectons: Drect Chnge n Busness Incoe Averge Effectve Overll Busness Tx Rte n Clforn 7 Chnge n Personl Incoe Tx Collectons personl ncoe nd sles txes $.4 Bllon x9.45% $467 Mllon $744 Mllon ess: Drect Cost n ost Frnchse Txes 8 Net Increse n Clforn Tx Collectons -$800 Mllon $4 Mllon As shon n the Tble, busness txes y ncrese by $467 llon. Snce soe of the ncresed collectons ould be due to ncresed property txes, soe of ths ncrese ould ccrue to locl governents. The Tble shos tht personl tx collectons y ncrese by $744 llon. When e subtrct out the estted $800 llon drect cost of lost frnchse txes, 6 It s portnt to note tht the overll busness tx rte does not nclude sles/use txes pd by busnesses. Accordngly, ddtonl but unknon stte nd locl revenues should be dded to the bove chnge n busness tx collectons. As prctcl tter, t s very dffcult to seprte sles txes pd nto busness verses personl coponents. 7 Approxtely hlf of ths tx rte s ttrbutble to corporte ncoe txes; the render s due to scellneous txes, nd sll ount s due to property txes see pror footnote 8 To the extent the current econoc donturn contnues, such lost revenues y be loer. Accordngly, the $4 llon estted gn to the stte could be hgher. Also, t s unknon ho uch less the $800 llon estte ould be f SSF ere de ndtory.e., soe frs ould py ore txes under requred SSF, so the $800 llon fgure ould be loer. 5

6 Doc pgs the potentl nnul net gn to the stte s estted to be $4 llon, n the long run 9. Concluson Usng results for sttes recently stchng to the SSF s benchrk, ths study esttes tht dopton of the SSF could result n pernent n equlbru ncrese of 44,000 jobs, nd net nnul revenue gn to the Stte of $4 llon n the long run. It s portnt to note tht unpredctble fctors such s contnued econoc donturn n the Stte could hve n effect on these esttes. A fnl observton s tht the Clforn SSF s electve, n contrst to nuber of sttes here ths ethod s ndtory. Fro tht perspectve, the Clforn SSF ould generlly pper to be hrless to frs hch chose not to utlze t. Recently Relesed Study by the AO In study dted My 6, 00 0, the Clforn egsltve Anlyst s Offce AO concluded tht the sngle sles fctor rule for Clforn should be retned. They noted tht the SSF prootes job groth, nd tht the bsence of n SSF ould put Clforn frs t copettve dsdvntge. 9 Such revenue gns cn be used to fund, ong other thngs, publc educton. Note tht soe double-countng lbet offsettng y be nherent n the bove revenue esttes, s follos. The overll effectve busness tx rte ncludes both txes pd by, nd ncoe relted to, pss-through enttes. On the other hnd, the personl ncoe tx collectons do not nclude ncoes fro such busness enttes. Fnlly, note tht the potentl nnul revenue gns to the Stte ght be s hgh s $.8 Bllon ssung tht the H et l 005 generl equlbru effects occur. 0 Reconsderng the Optonl Sngle Sles Fctor: An AO Report. Scrento: egsltve Anlyst s Offce My 6, 00 6

7 Doc pgs About the Author Chrles Chuck Senson, PhD, CPA, s Professor nd eventhl Reserch Fello t the Mrshll School of Busness t the Unversty of Southern Clforn, here he hs tught snce 987. Chuck hs prevously served s Vstng Professor t UCA nd Cltech. Author of ore thn 50 cdec reserch nd professonl rtcles on txton hch hve ppered n such econocs journls s the Ntonl Tx Journl, the Journl of Publc Econocs, nd the Journl of nd Econocs, Dr. Senson hs on the Tx Mnuscrpt Ard fro the Aercn Txton three tes. He s uthor of to tx texts nd s the Generl Edtor of the tretse Stte Txton: Prncples nd Prctce exsnexs, 009. Hs bo nd currculu vte cn be found t: 7

8 Doc pgs APPENDIX: TECHNICA PAPER ON THE EFFECTIVENESS OF SINGE SAES FACTORS FOR STATE TAXATION Chrles W. Senson Professor nd eventhl Reserch Fello Mrshll School of Busness Unversty of Southern Clforn os Angeles, CA Aprl, 00 8

9 Doc pgs ON THE EFFECTIVENESS OF SINGE SAES FACTORS FOR STATE TAXATION ABSTRACT Ths study odels nd eprclly tests the pct of stchng to sngle sles fctor SSF forul for stte corporte ncoe tx purposes. The study frst odels the optl locton choce decsons of fr n response to dfferentl stte ncoe pportonent rules hle controllng for dfferent tx structures nd tx rtes. The odel s then tested n fve sttes hch recently stched to sngle fctor pportonent rules. Results ndcte tht SSF ncresed eployent n the fve sttes exned.

10 Doc pgs ON THE EFFECTIVENESS OF SINGE SAES FACTORS FOR STATE TAXATION. INTRODUCTION A jor polcy utlzed by sttes to ttrct ne busness s tx ncentves. One tx ncentve s plcng hevy ephss on sles n pportonent forule; recently, fve sttes hve stched to the use of sngle sles fctor or SSF n pportonng ncoe, hch plces 00% eghtng on sles. The ntent of the SSF s to ttrct busness to stte. The purpose of ths pper s to nlytclly nd eprclly exne these ncentve effects usng ultstte fr. The odel s predctons re eprclly supported usng fve sttes hch recently stched fro double-eghted sles fctors to sngle sles tx fctors Georg, ousn, Ne York, Oregon, nd Wsconsn. The results hve sgnfcnt polcy plctons, not only becuse lkers pprently rely on ths ncentve n n ttept to ttrct ne busness nvestent nto ther sttes, but lso becuse the drect costs of these ncentves y be substntl. Ths pper odels fr hch cn vl tself of fvorble sles pportonent rules, n loctng/expndng to ne stte. Becuse the fr s decson s lso ffected by stte tx rtes nd structures, the odel lso llos for vryng tx rtes nd both untry nd seprte ccountng tx structures. The fr fces to coon scenros. The frst scenro s here the fr hs nrroed don ts locton choce to one stte due to copellng non-tx consdertons. Resources re then llocted to ths stte n response to vryng tx rtes, sles eghtng nd sourcng rules, nd overll tx structures untry versus seprte ccountng. The second scenro ssues tht the fr fces choce beteen to sttes, ech hvng vryng tx rtes, sles rules, nd untry versus seprte ccountng tx structures. To test the pct of fctor eghtngs, ths study exnes nturl experents desgned to gve best shot for esurble effect: fve sttes stchng to fro double-eghted sles fctors to Ths represents n ncresng trend tord SSF; 3 of the 46 sttes th ncoe txes hve SSF, nd nother 0 sttes llo SSF for certn ndustres. For exple, the tx expendture budget for Clforn esttes tht the cost of doptng the SSF ould be $800 llon nnully. 0

11 Doc pgs SSF fter 006. Georg stched to SSF th three yer phse-n strtng th sles eghtngs of 80% n 006, 90% n 007, nd 00% by ousn stched to SSF fter Ne York stched to 80% sles eghtng n 006, nd 00% n 007 nd lter yers 5. Oregon stched to SSF fter July, Wsconsn stched to 60% sles eghtng n 006, 80% n 007, nd 00% n 008 nd lter yers 7. Usng detled, locton-specfc fr dt th llons of opertons fro the NETS dtbse, nd dfferences-n-dfferences reserch desgn hch dentfes ffected versus unffected frs, the nlyss suggests tht such sttes experenced sgnfcnt ncreses n eployent fter SSF enctent. Becuse resource llocton/re-llocton effects re strongly ltered by forul pportonent nd untry tx structures, these re dscussed n the next secton.. STATE TAX RATES AND STRUCTURES. Incoe Tx Rules All but four sttes pose stte corporte ncoe tx. Rtes rnge fro %Io to 3.4%Indn. Although rtes do not typclly hve lrge nnul sngs, rte chnges of % re not uncoon for ny prtculr stte, n order to eet polcy objectves or blnce budgets. Eqully s portnt s rtes re the rules hch deterne the tx bse, such s pportonent nd hether the stte follos untry or seprte ccountng rules. All sttes requre tht ncoe of corporton be pportoned to the txng stte bsed on fctor forul; for ost sttes, t s the three fctor forul of the rto of sles, pyroll, nd property thn the txng stte to the corporton s totl sles, pyroll, nd property. Thus, f corporton hs opertons n ore thn one stte, ncoe txble n ech pportonng stte ll be the fr s busness ncoe both thn nd outsde the stte ultpled by the stte pportonent fctor s deterned by tht prtculr stte s 3 O.C.G.A Sec Georg s SSF pples to only nufcturers, producers, nd sellers of tngble person property. 4 Sec. 47:87.95F. ousn s SSF pples to only nufcturers nd erchndsers. 5 Sec Tx. Ne York s SSF ppers to pply to ll ndustres except fnncls nsttutons. 6 Sec ORD 7 Sec Wsc. Stts. Wsconsn s SSF pples to ll ndustres.

12 Doc pgs pportonent forul. Snce the jorty of sttes double eght the sles fctor n the pportonent forul, the ncoe pportoned to stte cn be represented s: Busness Incoe Sless Pyrolls Propertys Totl Sles Totl Pyroll Totl Property 4. Busness ncoe ether ncludes ncoe solely fro sngle corporton seprte ccountng, or fro cobned group of enttes hch re prt of the se untry group untry txton. For untry /cobned reportng sttes prrly, those est of the Msssspp Rver the untry ethod s ppled to deterne the extent to hch corporton s brnches nd ffltes re ncluded n pportonble ncoe nd n three-fctor pportonent forul. The so-clled untry tx defnes pportonble ncoe nd ncludes n the pportonent forul ncoe fro opertons consdered to be prt of untry busness of the corporton opertng n ts stte. The bsc chrcterstcs of untry busness re tht the corporton s opertons re dependent upon or contrbute to the busness conducted by the group, nd tht there s t lest 50 percent coon onershp or control beteen the corporton nd the corporte group 8. Untry sttes requre flng of cobned corporte ncoe tx report, hch ncludes ll ffltes consdered to be prt of the untry busness. Insted of the untry ethod, soe sttes use the seprte ccountng ethod, hereby only the ncoe of the entty conductng busness n the stte s ncluded on the corporte ncoe tx return. Txes n untry sttes re ffected by chnges n property, pyroll, or sles. Snce these re rel econoc choces, tx optzton y result n decresed pre-tx econoc perfornce, both vs-vs no-tx stuton, nd vs--vs the non-untry settng. Accordngly t s portnt to understnd not just the ncentve specfclly of SSF, but of generl fctor pportonent effects on the tx bse nd tx rtes s ell. The next secton dscusses such ncentve effects. 8 The contrbuton nd dependency test s one of severl tests for unty. The others re the three untes test unty of onershp, unty of use, nd unty of opertons; strong centrlzed ngeent; nd even flos of vlue.

13 Doc pgs. Incentve Effects of No Throbck Rule, nd Extr Sles Fctor Weghtng Absence of throbck rule to copute the sles fctor nd extr eghtng of tht sles fctor re fvorble tx tretents. Beteen 980 nd 000, fve sttes repeled ther throbck rules, nd the nuber of sttes hch plced ore thn equl eght on the sles fctor ent fro 8 7% to 8 6%. Absence of sles throbck essentlly converts stte nto terrtorl tx,.e., no tx on out-ofstte sles. To see ths, ssue fr nufctures n Stte A, nd sells ts output to Sttes A nd B. Assue the fr hs no nexus txble presence n B. The fr ll be txed on Stte A sles. Snce t hs no nexus n B, t cnnot be txed by B. If Stte A s non-throbck stte, sles n B re not txed by Stte A ether. It s dely beleved tht bsence of throbck rule encourges frs to locte n tht Stte, f they hve drect sles to out-of-stte custoers. A slr effect occurs th plcng extr pportonent eghts on the sles fctor n the pportonent forul. As dscussed n the next secton, fr s ultstte ncoe s pportoned nto stte bsed on the rtos of property, pyroll, nd sles n tht stte to property, pyroll, nd sles n ll sttes or orldde, f no ter s edge ltton s vlble. The hgher the eght stte plces on the sles fctor, the loer the eghts plced on the property nd pyroll fctors becuse the three eghts ust su to 00%. Becuse pportonent s essentlly seprte tx on ech of the three fctors s llustrted n the odel, loer eghts on property nd pyroll re essentlly loer txes on fcltes locted n the stte. Accordngly, the rgnl tx costs of loctng fclty hch hs out of stte sles n sngle fctor stte y be loer, ceters prbus, thn costs n non-sngle fctor sttes. Such loered costs of nvestent should ct s n nduceent to locton to or expnson n such stte..3 PREVIOUS RESEARCH Nuerous theoretcl studes cted n Wlson, 999 hve exned stte tx rtes fro cro, elfre-plctons perspectve. None of these studes consdered the effects SSF. Hoever, there hve been fe theoretcl studes hch hve focused on the effects of the untry tx on the 3

14 Doc pgs fr. McClure 98 found tht forul pportonent s slr to seprte tx on pyroll, property, nd sles. Focusng on ncdence, McClure found tht forul-bsed stte corporte ncoe txes ere lkely to be borne by resdents of the txng stte consuers, oners of lnd, nd oble cptl. Follong up on the McClure98 de tht the untry tx s three seprte txes, Gordon nd Wlson 986 seprtely nlyzed the effects of the fctors. Ther odel found tht hen sttes hd dfferent tx rtes, the sles fctor encourged cross-hulng of output sellng n nother stte, the property fctor provded ncentves not to concentrte opertons n one stte, nd the pyroll fctor nduced frs to consoldte opertons nto one stte. Wlls nd Senson 00 odeled the ntercton of untry/seprte ccountng structures nd chngng tx rtes on nterstte resource llocton, ssung the fr lredy hd exstng opertons n both sttes.e., there s not ne choce locton decson per se. They found tht hen the fr fced untry structures n both sttes, rte chnges encourged the fr to ove resources fro the hgher tx rte stte to the loer tx rte stte. In contrst, hen the fr s opertons ere only n seprte ccountng sttes, tx rte dfferentls beteen sttes hd no ffect on resource llocton. When the fr operted n both untry nd seprte ccountng stte, only rte chnges ffectng the untry stte resulted n resource llocton, nd even then the resource rellocton s less thn n the cse of here the fr operted exclusvely n untry sttes. Eprcl evdence on the untry tx s provded by Moore, et l. 989 ho ppled the Crlton 983 locton choce odel to foregn nvestent. Foregn frs ere used becuse the lterture suggested tht they should respond uch ore to regonl ncentves gven fvorble tx ncentves thn should doestc frs. The tx vrble s bfurcted nto overll effectve tx rtes clculted usng the odels n Vnes, et l. 994, nd duy vrbles ere used to ndcte the presence of untry tx structures. Results ndcted tht foregn frs locton choces ere unresponsve to overll tx rtes, but negtvely nfluenced by the presence of untry tx structures. The fndngs of Moore, et l. 989 ere essentlly replcted nd corroborted by Coughln, et l.99. More recently, Gupt nd Hofnn 003 ppled pnel dt nlyss cross ll sttes, usng locton choce odel slr to Moore et l. Regresson results found tht ne cptl 4

15 Doc pgs spendng s negtvely nfluenced by untry tx structures. The study lso found tht loer tx rtes nd ncentves for ssets n tht order ncresed cptl spendng. The resons for expectng the dsncentve effects of untry tx structures ere not guded by forl theory.e., odelng, n the bove eprcl studes. Slrly, these studes ere not guded by forl theory th respect to the ntercton of tx rtes nd dfferences n structures untry versus non-untry txton. These studes lso plctly ssued tht loer tx rtes nd/or n bsence of untry ccountng ethods ould utotclly provde n ncentve to nvest n stte. Ths s not necessrly the cse, snce locton choce ffects fctor nd pont-of-sle loctons, hch n turn ffect ncoe lloctons beteen sttes. Thus, t y be possble for loer tx rte sttes to hve lttle or no coprtve dvntge. 9 Wth regrd to bsence of throbck, nd extr eghtng on sles, no theoretcl nd only three eprcl studes exst on these to effects. Eprclly, lssen nd Shkelford 999 found tht hle nufcturers shpents fro throbck sttes ere decresng n corporte tx sttes, such shpents ere not senstve to sles eghtng fctors. By ther on dsson p. 387, results should be cutoned becuse of lck of rch theory, nd becuse of the ggregte nture of the dt stte totls, nsted of fr dt, ere used. Prevous reserch hs deonstrted tht hgher eghts on sles fctors generlly ncrese econoc groth nd n prtculr, eployent n sttes hch hve such hgher eghts 0. Usng ggregte dt, opez nd Mrtnez-Vzquez 998 found tht ndustres vred sgnfcntly n hvng ther ncoes ether under- or over-pportoned by vrous sttes. ghtner 000 eprclly found tht stte tx rtes, ore so thn forul pportonent, ffect stte eployent groth. One study specfclly looked t the pct of Clforn stchng to SSF. Edston nd Arze 00 used 9 Other stte ncoe tx studes not exnng the pct of untry structures or ther nterctons th tx rtes nd ncentves cn be found n lterture reves by Brtk 994 nd Wsylenko 997. Slrly, the nterested reder s referred to Goolsbee nd Myde 000, Ppke 987; 99, Annd nd Snsng 000, Wener 996, Edston 00, Edston nd Arze 00, Hnes 996, nd lssen See Goolsbee, A. nd E. Myde Covetng Thy Neghbor s Mnufcturng: the Dle of Stte Incoe Apportonent, Journl of Publc Econocs 75000, nd ctes theren. 5

16 Doc pgs cro sulton odels to predct tht stchng fro sngle to double-eghted sles fctors ncrese n stte eployent nd cptl. Usng dync coputble generl equlbru CGE odel, bsed n prt on Goolsby s eprcl odel, H et l 005 estted tht such stch ould result n ncresed Clforn eployent nd tx revenues. By ther on dsson, H et l cknoledged tht CGE odels re sgnfcntly drven by ssuptons. Gupt et l 009 use ggregte stte dt nd estte tht up to 6% of the corporte ncoe tx bse for sttes hvng ncresed sles eghts hs eroded due to extr eghtng of the sles fctor. Dubn 00 esttes tht tx cpcty the corporte ncoe tx bse ncresed for soe sttes, but decresed for others, s result of ncresed eghtng of sles by sttes fro Fnlly, surveyng the lterture, the Clforn egsltve Anlyst s Offce AO concluded tht SSF dopton ould ncrese Clforn eployent hen effectve n 0. 3 In contrst to the bove studes hch used lrgely ggregte dt, ths study proposes to use fr level econoetrc estton ethodology. Ths unque ethodology s enbled by the recent vlblty of fr level dt, dscussed belo. Fr level studes llo ore precse esttes of effects here, the ntroducton of the SSF thn cro odels, nd llo for specfc, fr level predctons. 3. MODE 3. Generl Model The nlyss begns th sple odel of fr hch opertes n ult-stte envronent. Although I use nufcturng exple, n prncple, the odel cn be generlzed to ny ult-stte enterprse here vlue s dded by vrous coponents of the enterprse. To exne the effects of H, W., Alberto, J. nd C. Groves, Apportonng Corporte Incoe: If Clforn Adopts the Sngle Fctor, Wht Wll be the Econoc nd Revenue Ipct?. Meo, August 005. A lterture reve of pre-006 SSF studes cn lso be found n Mzerov, M. 005, The Sngle Sles Fctor for Stte Corporte Txes: A Boon to Econoc developent or Costly Gvey. Meo, Center on Budget nd Polcy Prortes. 3 Reconsderng the Optonl Sngle Sles Fctor: An AO Report. Scrento: egsltve Anlyst s Offce My 6, 00 6

17 Doc pgs SSF, t s portnt to lso consder the collterl nd soetes countervlng effects tht other spects of stte tx structures nd rtes y hve. To ccoplsh ths, the odel of Gordon nd Wlson 986 s extended by exnng the effects of the ost prevlent ncentves: the bsence of sles throbck rule, nd extr-eghtng of the sles fctor. In dong so, t consders the effects of ll three fctors sultneously sles, lbor, nd cptl; Gordon nd Wlson consdered ech of these fctors ndependently. Ths three-fctor settng llos for ore relstc study, provdng for substtuton of fctors of producton nd sles both thn nd cross sttes. Addtonlly, ths study exnes control for the cse of ultstte fr opertng n both untry nd non-untry stte. The settng s portnt becuse over hlf of the sttes follo non-untry ccountng, nd t s thus lkely tht ny ultstte copnes encounter both types of sttes, sultneously, n ther opertons. Fnlly, snce tx rte dfferentls cn encourge frs to lter resource llocton, the study controls for dfferentl tx rtes n the odel s ell. 4 The study odels stylzed nufcturng fr th custoers n Stte nd potentl custoers n Stte. The fr s consderng expndng opertons nto Stte due to fvorble dend condtons. Thus, the fr does not fce locton choce decson per se. Ths serves s useful strtng pont to the pure locton choce odel, dscussed lter n the pper. To splfy the nlyss, the study ssues tht trnsctons costs of ovng resources to ny Stte re equl nd exceed return on nvestent requreents. Thus locton costs cn be gnored thout generlty. The fr s clssc exple of untry busness n tht ts ultstte opertons re functonlly dependent on ech other, th ts hedqurters n one stte, nd opertons n nother stte, nd clerly hs txble nexus or busness connecton n ech of the sttes. The nufcturng process begns t the fr's hedqurters n Stte, nd the fr ntns producton fcltes n Stte s ell. The fr copletes producton nd servces custoers fro the respectve locl fclty. The study odels the nufcturng process s potentlly dvsble t ny stge. Tht s, t ny pont n the nufcturng process, the fr could shp the nteredte or prtlly copleted 4 It s portnt to note soe dfferences beteen ths study nd tht of Gordon nd Wlson 986. Ther study exnes only untry tx structures, heres ths pper looks t both untry nd non-untry structures. Also, ths study ssues tht cptl s fully tx deductble, heres Gordon nd Wlson ssue 50% deductblty. Wth regrd to ths ltter dfference, ddtonl sultons th 50% deductblty ere conducted, nd no qulttve dfferences ere found. 7

18 Doc pgs product fro the nufcturng center t the hedqurters to the locl fcltes for copleton nd sle. The fr ncurs shppng chrge for sendng the product fro the hedqurters to the locl fclty n Stte bsed on the nuber of unts shpped. The study ssues tht the locl fclty tht copletes the product nd sells to custoers n Stte s djcent to the hedqurters, nd thus no shppng chrge s ncurred on those unts. The qunttes sold to custoers n Sttes nd re denoted, respectvely, s nd. As ngeent's objectve s to xze the fr's pretx proft, the study ntlly gnores stte ncoe txes. Bsed on the fr's revenue functon nd the costs t fces, ngeent chooses the level of cptl nd lbor to eploy t ech of the fr's three fcltes the nufcturng center nd the locl fcltes n ech stte so s to xze the excess of revenue over cost. In kng these decsons, ngeent s constrned by exogenously deterned producton functons. Mngeent ust lso choose the pont n the nufcturng process t hch producton ll shft fro hedqurters to the locl producton fcltes the degree of centrlzton. Denote ths s the choce of φ the frcton of the nufcturng process perfored t the hedqurters, th - φ beng the percentge perfored t the locl producton fcltes, hch s beteen zero nd one. More forlly, ngeent chooses,, nd φ Є {,, } 5 so s to x π = R, C,, subject to the producton functons for the nufcturng fcltes. Assue the fr opertes n n perfectly copettve rket nd fces donrd-slopng dend curve n ech stte. Specfclly, ssue the nverse dend functon s P = j b j, here j Є {, }. Ths leds to the fr's revenue functon:, b R = b. b 5 For nottonl purposes, I use the subscrpt to ndcte producton or fctors of producton t the fr's nufcturng center, nd I use the subscrpts nd to ndcte producton or fctors of producton t the fr's locl producton fcltes n, respectvely, sttes nd. 8

19 Doc pgs Assue the cost of producton conssts of the rentl rte or, n the lterntve, the rte of return on cptl r, the ge rte pd for lbor, nd the cost s of shppng unt fro the nufcturng center to the locl producton fcltes n Stte. Assung sngle rentl rte on cptl for ll fcltes; hoever, llos ge rtes to dffer beteen the sttes. Forlly, odel the cost of producton s:, r r r C = s. c Assue tht producton follos generlzed Cobb-Dougls producton functon here Y = α β th Є {,, }, α nd β >0 nd <. For the hedqurters, Y = φ. For the locl producton fcltes, Y j = j - φ th j Є {, }. Assue tht the productvty of cptl does not depend on ts locton; ccordngly, β s the se for ll three producton fcltes. A relstc settng should llo for dfferences n lbor beteen orkers n dfferent sttes. For exple, the verge skll level s lkely to be dfferent s s the verge level nd qulty of educton. One y of veng ths s to ssue tht orkers th the requste skll nd eductonl levels re vlble n ech stte, but tht locl dfferences n the supply nd dend for those orkers ll potentlly result n dfferent prces for ther lbor. 6 The study hoever, nsted reflects these dfferences n the ge rtes,, rther thn n α. The odel s shon grphclly n Fgure. Cobnng equtons nd b nd specfyng the producton functon constrnts, the pretx odel s shon sybolclly n : 6 Another y to ve ths s to consder the lbor vrble,, s reflectng soe unt of hun productvty rther thn soe nuber of orker-hours. Tht orkers n one stte y tke longer to cheve tht unt of hun productvty s reflected, ceters prbus, n hgher effectve ge rte,. The fct tht t ould tke orkers n one stte longer to cheve ths unt of hgher productvty could be reflected n loer nonl ge rte, but other fctors y lso nfluence the nonl ge rte, so the effectve ge rtes y stll dffer beteen the sttes. I beleve ths odel s generlzble n to portnt respects. Frst, I beleve t s generl enough to encopss both the decson of ho to eploy resources thn exstng fcltes nd the decson s to the sze nd scope of ne fcltes. The odel gnores the trnsctons costs ssocted th these decsons, but f the openng of ne fclty or the expnson of n exstng fclty s done through rentng buldng nd equpent nd hrng locl eployees, the trnsctons costs should be reltvely lo. Secondly, the odel cn be generlzed to the cses of erchndsers nd servce copnes. In both cses, f proxty to custoers nd clents s necessry or expected, the fr's choce of ho bg fclty to eploy cptl nd ho fully to stff t lbor ll ffect the fr's effectve stte ncoe tx rte. Ths pct on effectve stte tx rtes could nfluence, for exple, consultng fr's decson hether to open n offce n nother stte on full- or prt-te bss. Whle the specfcton of the preters e.g., α nd β re lkely to chnge, the generl for of the odel should stll pply, nd the results y be qulttvely slr. 9

20 Doc pgs Mx π = subject to: φ s, b b r α β = Y =, α β φ = Y =, nd α β φ = Y =. When pretx profts re xzed, rerrnged s MP r = th MP MP MP β r β =. Therefore, =, 7 hch s α α β = ddng the pproprte subscrpts. 3 αr To solve ths proble, the frst step s to substtute 3 nto ech constrnt for nd solve for the respectve n ters of the s, φ, nd exogenous vrbles. Ths result s then substtuted nto. The next step s to hold the s constnt nd solve for φ by dfferenttng the resultnt equtons th respect to the exogenous vrbles to obtn the frst order condtons FOC. Unfortuntely, the resultnt equtons nvolve hgh degree polynols for hch contnuous for soluton cnnot be found for the entre syste sultneously. Hoever, soe prtl fndngs cn be derved s shon n the follong pges. 3. MODE WHERE FIRM HAS SEECTED ONE STATE: Both Sttes Use Seprte Accountng Before exnng the effects of tx ncentves, t s useful to frst exne the effects of nonuntry txton on resource llocton. Here, one cn look seprtely t the effects on ech stte. Frst, note tht non-untry txton of subsdry th only sngle-stte opertons, does not nvolve the use of fctor pportonent. 8 Hence, txton of the fr s slr to tx on pure profts, hch s non-dstortonry. Wth ult-stte txton nd trnsfer prce set equl to verge unt cost, I cn seprte totl profts nto to peces, correspondng to the tx code s follos: 8 Technclly, fctor pportonent y be eployed, but snce the three fctors re 00% becuse the subsdry hs opertons n only one stte; t s s f fctor pportonent s gnored n ths cse. 0

21 Doc pgs π = π π π S S S π S =, = b b r r p, t p t nd s. 4 Note tht the nufcturng center costs re ncluded plctly, snce p t = r. The trnsfer prces desgnte ho uch of the nufcturng center cost s deductble n ech stte. Technclly, ll those costs re deductble n Stte, but the Stte fr ust lso recognze revenue fro sles to Stte of the unfnshed product equl to p t. If the trnsfer prce s treted s fxed, then the to sttes producton nd sles decsons cn be de ndependently. In tht cse, the txes re proportonte to econoc profts. It s ellknon result n publc econocs e.g., Atknson nd Stgltz, 980, p. 3 tht tx on pure profts does not dstort fctor nputs or sles decsons. Hence, ny effect of non-untry tx on resource llocton ust be due to n effect on the trnsfer prce tself, hch ould be second order n nture. As noted, the trnsfer prce s the verge unt cost of the nufcturng center. Snce the producton functon exhbts decresng returns to scle, the trnsfer prce s ncresng n totl sles. Ths ens tht ech stte poses n externlty on the other stte. By ncresng sles n one stte, costs ncrese for the other stte. Gven ths externlty, n the globl optu soluton, t s desrble to under-produce n ech stte such tht the rgnl fter-tx proft n ech stte of n ddtonl unt exctly equls the externlty posed on the other stte. If the tx rte ncreses, the rgnl pre-tx proft ust ncrese to ntn ths blnce. Therefore, sles cn be expected to declne slghtly n response to tx rte ncrese due to ths ndrect effect. Anlytclly, gven 4 nd th π p S defned s Stte pretx proft: p π S p pt π S / = =. pt, 5 The left hnd sde of 5 s functon of. Defne t s

22 Doc pgs pt h = p π S /. Gven tht the trnsfer prce s convex snce producton s concve nd pre-tx profts re concve n output, h s onotone ncresng, hch ples tht ts nverse s lso onotone ncresng. Defne tht nverse s H = h -. Then H > 0. Fro 5, = H, = H ' < 0. 6 It cn be redly deonstrted tht 0 snce decrese n decreses the trnsfer / > prce, provdng n ncentve to ncrese ths effect ll prtlly offset the chnge n p t, so tht on net the pct of the tx rte on the trnsfer prce ll be sll. The effect of the tx rte on Ф s uncler; t s possble for the sgn to be ether postve or negtve. As consequence, the effect of the tx rte on lbor nd cptl s lso uncler, lthough lbor nd cptl n ech stte re lkely to ove n the se drecton s sles. The nlyss of s dentcl to the nlyss of. The effects of tx rtes n ths settng re surzed s follos. Frst, hgher rtes n Stte ll decrese tht stte s sles nd ncrese the Stte sles fro 6. Conversely loer rtes n Stte ll ncrese tht stte s sles, nd decrese sles n the Stte. Second, tx rtes hve n bguous effect on other decson vrbles n the fr. Fnlly, ll effects of tx rtes re second order n nture. To exne the effects of dfferent eghtng schees nd the bsence or presence of throbck rule, one cn dd ne, nerby Stte 3, nto hch the fr sells fro ts Stte opertons, but hs no nexus lbor or cptl. We ust frst ke n ssupton bout sles de nto Stte 3 hch hve been prtly nufctured n Stte. Assue tht goods de n Stte cn be sold both n Stte nd nerby Stte 3. Θ s the frcton of Stte producton sold to Stte custoers, nd -Θ s the proporton sold to Stte 3 custoers. Snce Sttes nd 3 re

23 Doc pgs contguous, ssue tht dend functons re slr beteen the to sttes. Rerte the thrd equton n 4 here there s throbck of Stte 3 sles 3 nto Stte.e., Stte 3 sles re txed by Stte s: π S = Θ[ b [ Θ 3 r 3 b p ] t s ] 4 Snce txes re the dentcl on sles nto ether stte, they re non-dstortonry on nterstte sles decsons. The rte of substtuton beteen stte sles s: Θ = 3 b b 3 4b The tx rtes cncel out, nd Θ s unffected by txes. Where Stte hs no throbck, Stte 3 sles escpe ncoe txton, nd 4 s rertten: 3 b3 π = Θ[ b r p s ] 4c S t The rte of substtuton of sles beteen sttes s: Θ = b b 3 3 4d Coprng 4b to 4d, e see tht the fr ll shft sles sourced fro Stte to Stte 3, ceters prbus. It cn lso be shon tht ncreses due to ncresed rgnl proft due to nontxblty of Stte 3 sles. As th the nlyss n 6, f 0 ; conversely, drop n the effectve results n n ncrese n nd drop n. As th the nlyss n 6, the effect on φ s bguous, nd the trnsfer prce ncreses n both sttes, cusng hgher costs negtve externlty n Stte. The forgong nlyss gnores the effects of pportonent eghts. To exne the pct of pportonent eghts, defne the eghts for sles, property, nd pyroll s S,, nd, 3

24 Doc pgs respectvely. Snce ech s defned s per cent, the su of the three eghts ust equl one. Rerte the proft equton for the throbck stte s: π S = [ S Θ [ p t b ] [ s ] [ S Θ ] [ r ] 3 b 3 ] 4e Dfferenttng 4e sequentlly for ncreses n S, decreses n nd, nd fctorng out n exogenous constnt here, e get: b Θ 3 b = r Θ 4f Thus, ncresed eghts on sles hve uted ncentve effect, n ths settng. The ntuton s s follos. Incresed sles eghts re effectvely tx on sles; the rgnl revenue product curve for the fr shfts don n t every level of sold n Stte 3. Slrly, loer eghts on lbor nd cptl re tx benefts t every level of fctor nputs, shftng the rgnl cost curve don/n. Thus, the net effect dependng on the shpe of both curves s lttle or no chnge n, th no resultnt effect on other decson vrbles. 3.3 MODE WHERE FIRM HAS SEECTED ONE STATE: Both Sttes Use Untry Accountng Before exnng the effects of pportonent fctors nd sles throbck, t s useful to frst exne the effects of untry tx structures producton nd nvestent decsons. To exne the effects of untry tx structure n both sttes, the proft equton s ultpled by tx rtes, resultng n: subject to: b b r Mx π = s u φ = Y = α β α β φ = Y =, nd α β φ = Y =, th, b 4 b b u = 4

25 Doc pgs b 4 b b. 7 Note tht the pportoned untry tx, u, s the stndrd pportonent forul, equton shon n the begnnng of the pper, dpted to the property, pyroll, nd sles preters of the odel. Sles re doubled-eghted n the pportonent forul. In exnng nd 7, e see tht the untry tx s, s noted by McClure 98 nd Gordon nd Wlson 986, slr to seprte tx on ech of sles, cptl, nd lbor. As th the non-tx odel bove, t s too coplex to solve nlytclly s n entre syste. Hoever, by kng soe splfyng ssuptons, soe coprtve sttcs cn be derved. Essentlly, n ncrese decrese n the tx rte n one stte results n oveent of producton nd sles out of nto tht stte nd nto out of the other stte. The effects of tx rte chnges re uch ore coplex n the untry tx settng becuse of the pportonent fctor. In order to nlytclly deterne the effect of chnges n tx rtes on the decson vrbles, t s necessry to seprtely consder the effects on the sles qunttes nd nd onφ. The lbor nd cptl vrbles re solely deterned by the sles qunttes ndφ, through the stndrd Cobb-Dougls reltonshps, gven,, nd r. Unfortuntely, the ntercton beteen the s nd φ s too coplex to fcltte nlyss thout splfyng ssuptons. When nlyzng the effect of tx rtes on nd, ssue tht φ does not chnge. Slrly, hen nlyzng the effect of tx rtes onφ, ssue tht nd do not chnge. The ndrect effects gnored re lkely to be of very lo order, so the splfyng ssuptons should not be probletc, lthough ths s not knon th ny certnty. Frst consder the effect of chnges n tx rtes on φ holdng the s constnt. Consder the frst order condton for the optl choce ofφ : 5

26 6 0 = = φ φ φ φ φ φ π φ φ π r u p u 8 here π p s pre-tx proft. Defne. φ φ φ φ φ φ φ = r f Also defne F = f --. It cn esly be shon tht 0 > φ nd 0 > φ for ll. Thus, 0 ' > φ f. The nverse of every onotone functon s lso onotone; hence, F > 0. Rerrngng 8, nd u p, f u φ π φ = 9. F u p = φ π φ u Holdng the s constnt, φ s only effect on u s through shft n property nd pyroll beteen the nufcturng center nd the Stte fnl producton center. Incresng φ ncreses the eght gven to Stte for those to coponents:. / / 4 = φ φ φ u Both prtl dervtves n the brckets re postve, thus. 0 / > φ u Gven 9, 0. / ' < = φ π φ π φ u u p u u p F 0 Note tht n the bove dfferentton, the nor effect tht the tx rte dfferentl cn hve on u p π. s gnored. Tht s necessry splfcton tht s not expect ed to ffect the results. No consder the effect of chnges n tx rtes on sles qunttes, holdng φ constnt. The frst order condton s 0 = = u p u s r b π π Doc pgs

27 7 Defne. s r b g = Also defne G = g -. Due to decresng returns to scle, the second dervtves of cptl nd lbor usge th respect to re ll postve. The second dervtve of th respect to s 0. Therefore, g ' > 0 nd G ' > 0. Rerrngng yelds. u u p g = π. = u u p G π. / ' π π = u u p u u p G Holdng φ constnt, ncresng ncreses stte 's eght on ll three fctors.. / / / 4 = u b b b The prtl dervtves re ll postve for = nd negtve for =. Thus, 0. / nd 0 / < > u u Gven tht G ' > 0, ples tht 0 nd 0 > < 3 The effect of tx rtes on the lbor nd cptl nputs cn be derved fro the effects on the s nd φ. Unfortuntely, these effects rrely ll ork n the se drecton, so coprtve sttcs re cler n only to cses, those nvolvng nd. Both of those re ncresng n, decresng n φ, nd unffected by. Therefore, Doc pgs

28 Doc pgs > 0 nd > 0. 4 The effect of tx rtes on nd s uncler snce they re postvely ffected by nd negtvely ffected byφ, ledng to conflctng effect th n bguous net result. nd re lso bguous snce they re postvely ffected byφ,, nd. The effects of nd re roughly offsettng, so t s lkely tht the φ effect dontes, n hch cse < 0 nd < 0. 5 In sury, the effects of tx rtes n the pure untry tx settng re s follos. Frst, hgher rtes n Stte or loer rtes n Stte result n decreses n φ fro 0 decresed nd ncresed fro 3, ncresed nd fro 4, nd decresed nd fro 5. Second, hgher rtes n Stte or loer rtes n Stte result n ncresed φ fro 0, decresed nd ncresed fro 3, decresed nd fro 4, nd ncresed nd fro 5. Fnlly, there s no predcton on the effects of txes on nd. The follong prgrph essentlly sys tht the fr ll sply ove fctors of producton fro the hgh tx rte stte to the lo tx rte stte, n order to decrese ncrese the ount of ncoe llocted to the hgh lo tx rte stte. Of course, these re ceters prbus condtons. Becuse of decresng returns, ddtonl cptl nd ddtonl lbor re ore expensve per unt s the fr dends ore of the n the lo tx stte. Slrly, the prce of the fr s output, per unt, declnes s the fr produces nd sells ore n the lo tx rte stte, due to prce elstcty n the output rket. In contrst, per unt fctor costs declne, nd per unt sles prces ncrese, n the hgh tx stte, s the fr scles bck opertons there. These to effects should ctully reduce pretx profts. The queston then becoes to ht degree the fr oves fctors of producton or substtutes beteen the nd sles n order to xze fter-tx profts. 8

29 9 The effects of no sles throbck rule re s follos. Wth throbck, the prevous results re unchnged, snce t s s f Stte 3 s prt of Stte for tx purposes. When there s no sles throbck rule, nd sles re double-eghted, the lst ter n 7 s rertten s: Θ Θ = 3 4 b b b b u Θ Θ 3 4 b b b b 7 Wth no djustents to the decson vrbles, 7<7. Snce the nuertor of the sles ter n Stte does not nclude Stte 3 sles, there s both n ncoe nd substtuton effect for the fr n Stte. Stte sles re shfted to Stte 3; both nd 3 ncrese s ell. Ths ltter effect ctully hs postve externlty to Stte : the denontor of the sles fctor ncreses resultng n decrese n. But there s lso negtve externlty to Stte ; ncresed producton t the n plnt ncreses the trnsfer prce. The effects of ncresed eghtng of the sles fctor n Stte s s follos. Rerte 7 to nclude pportonent eghts for sles, property, nd pyroll s follos, ssung throbck: Θ Θ = } { } { } { b b b b b S u } { } { } { b b b b S 7b Wht hppens hen the tx rege n Stte plces ncresed eght on sles? There re countervlng effects on resource llocton. Whle the fr s rgnl cost curve shfts donrd due to decresed eght, nd thus tx, on property nd pyroll, the rgnl revenue curve shfts donrd s ell due to ncresed eght, nd thus tx, on sles. Assung the presence of throbck rule, 7 s rertten th pportonent eghts: Θ Θ = } { } { } { 3 3 b b b b S u Doc pgs

30 30 7c There s no effect on the second ter, follong the rguents bove relted to 7b. Nor s there ny chnge n Stte 3 sles the lst ter, snce these sles re not subject to ncoe tx nyy. 3.4 MODE WHERE FIRM HAS SEECTED ONE STATE: One Stte Untry, One Stte Uses Seprte Accountng Fnlly, xed tx structure s nlyzed, n hch one of the sttes s untry, nd the other hs non-untry tx structure. Before exnng the pct of tx credts, the pct of the untry/seprte ccountng structures s exned. Under ths specfcton nd ssung tht Stte s the non-untry stte nd tht the fr seprtely ncorportes ts opertons n ech stte 9, 4 s rertten: ] [ Tx s r b b Mx u = π subject to: 30, 4 = b b b u nd, s r p b Tx t = r p t = 6 If Stte s the non-untry stte, slr trnsforton of 4 pples:, ] [ Tx s r b b Mx u = π nd 4, = b b b u. r p b Tx t = 7 30 The prevously stted producton functons constrnts contnue to pply but re otted here so s to concentrte on the ncoe txes. Doc pgs

31 Doc pgs Here, p t s the trnsfer prce chrged by the nufcturng plnt t the hedqurters for the nteredte goods trnsferred to the fcltes n Stte. The trnsfer prce s the verge unt cost of the nufcturng center. Note tht the trnsfer prce s not decson vrble n the optzton, lthough t does depend on totl sles ndφ, th p t ncresng n both. Upon exnton of 6, t s cler tht the to txes enter the objectve functon n very dfferent ys, ledng to very dfferent plctons of chngng ether rte. Frst, f there re reltvely hgher loer rtes n the stte subject to the untry tx stte n the bove exple, the fr hs the ncentve to ove property, pyroll, nd sles out of nto the stte to reduce the frcton of profts pportoned to the stte. As th the cse of to untry sttes, the ount of shftng of resources out of nto the untry stte s tter of degree, lted by the donrd slopes of dend n the to sttes s ell s the decresng returns nture of producton t ech ste. Second, f tx rtes re hgher loer n the non-untry stte, ths cuses roughly proportonte decrese ncrese n fter-tx profts fro tht stte regrdless of producton nd sles decsons. Hence, e ould expect nl shft n resource llocton. The drecton of tht shft, hoever, s uncler s nuber of conflctng forces exst. The n consderton s the nture of the externlty tht the non-untry stte poses on the other stte by ncresng ts sles nd producton. There re ultple externltes. The net effect of these externltes could be postve or negtve but s ore lkely to be postve f the non-untry stte s stte snce one externlty s n ncrese n fctor eghts for the nufcturng center hch s fvorble for the untry stte f the untry stte does not contn the nufcturng center nd unfvorble f t does. The exstence of n externlty nduces the fr to devte fro the non-untry stte s decentrlzed proft-xzng sles.e., the optu gnorng the externlty posed on the other stte. Specfclly, the fr ll trdeoff effcency losses n the non-untry stte th externlty benefts for the untry stte. The hgher the non-untry stte s tx rte, the loer the fter-tx cost of devtng fro the decentrlzed optu snce the governent shres n ny reducton n pre-tx profts n tht stte. Therefore, htever dstorton s nduced by the externlty ll be excerbted by n ncrese n the non-untry 3

32 Doc pgs stte s tx rte. The tx rte n the untry stte hs n equvlent effect to the tx rtes n the prevous odel here both sttes re untry. All coprtve sttcs follo. The non-untry tx rte, hoever, s ore coplcted. Recll tht hen both sttes re non-untry, tx rtes hve n effect on resource llocton only becuse n externlty exsts due to decresng returns to scle t the nufcturng center tht nduces overproducton n ech stte reltve to the decentrlzed optu. At hgher tx rtes even greter underproducton s rrnted to blnce the externlty. In the cse here the other stte s untry, three externltes exst for sles n the non-untry stte. Specfclly, ncresed sles n the non-untry stte result n: hgher unt cost t the nufcturng center, ncresng costs for the other stte negtve externlty, hgher fctor eghts for the non-untry stte, reducng txes n the other stte postve externlty, nd hgher fctor eghts for the nufcturng center stte, ncresng or reducng txes n the other stte dependng on hether tht stte contns the nufcturng center postve externlty f Stte nd negtve externlty f Stte. The overll ncentve to under- or over-produce n the non-untry stte reltve to the decentrlzed optu depends on the net effect of these externltes. If the negtve externltes donte, the stte ll underproduce nd hgher tx rtes ll led to reducton n sles. If the postve externltes donte, the stte ll overproduce nd hgher tx rte ll led to n ncrese n sles. It s possble to defntvely sgn the net externlty effect; hoever, gven the nture of the thrd externlty, the effect of the non-untry tx rte on n-stte sles should be uch ore postve f Stte s the non-untry stte thn f Stte s the non-untry stte. As n the cse th both sttes non-untry, the effect of the non-untry tx rte on φ s bguous. The effects on lbor nd cptl re lkese bguous, but re lkely to correspond to the chnge n sles. In sury, the effect of tx rtes n the cse here one stte hs untry txton nd the other stte does not re s follos. Frst, hen the tx rte s hgher n the untry stte, resources flo out of t, nd nto the non-untry stte except for nd, for hch there re 3