Working Paper 01-3
by Charles Ian Mead

This paper extends the theoretical model of Hall and Jorgenson (1967) in order to examine major changes in state and local tax laws and their effects on the variation in tax burdens across states. A user cost of capital series that accounts for the major provisions of federal and state tax laws is calculated for representative firms in all forty-eight contiguous U.S. states at five-year intervals during the period 1963 to 1997. Previous studies of this topic have been limited to estimates of effective marginal tax rates for only a handful of locations and time periods. The results suggest that state and local tax policies have little effect on the variation in the user cost of capital across states. Further, state and local taxes have a large effect on the variation of effective marginal tax rates across states, which is consistent with what others have found. The implication is that state and local tax policies have little effect on state-specific investment because this variable is likely to be more directly related to the investment decisions of firms.

JEL classification codes: E22, H25, H73

PDF version of paper