Can state tax policies be used to grow small and large businesses

I. INTRODUCTION Small businesses are extremely important to the U.S. economy according to the U.S. Small Business Administration (SBA). (1) Research indicates that small businesses account for a very large share of employers and U.S. economic output. (2) As such, they receive a great deal of attention from policymakers who seek to attract these businesses to their jurisdiction through various policies. Given this attention paid to small businesses, a significant body of research has developed that examines the effect of tax policy on small business activity. Most of this research has focused on federal policies, with only a few studies focusing on how state-level policies may affect small businesses. This comes despite the fact that state policymakers create policy with the stated intent of helping grow small businesses. We contribute to this growing body of research by considering the effect of state tax policy on a broader set of measures of small business activity--firm growth, establishment growth, employment growth, and payroll growth. Previous research has tended to focus on one specific measure of business activity, such as self-employment or business start-ups, or on a particular set of industries. We contribute by considering various measures of small business activity, versus focusing on one specific measure. Furthermore, by considering different measures of business activity, we are able to provide insights into what specific dimension of small business activity is affected by different state policies. Our research will help to inform policymakers as they create legislation with the intent of promoting small business growth. To estimate the effect of tax policy on small businesses, we use a longitudinal database with detailed information on state tax policies for all 50 U.S. states from 1989 through 2011. Using these data, we estimate a series of regression models to determine the effect of a broad set of state-level tax policy measures, and other control variables on the growth rate of our four measures of small business activity. Our econometric approach and the set of tax policy parameters that we consider largely follows that of Bruce and Deskins (2012), who analyze two measures of self-employment and its relationship to state tax policy using data from 1989 through 2002. In a more marked departure from the existing literature, we also estimate a series of models in which we replace our small business measures with parallel large business measures to understand how, if at all, the effect of state tax policy on large business activity differs from that of small business activity. There are several reasons to believe that large businesses may respond differently than small businesses to state tax policy. For instance, large businesses may hold stronger bargaining power and thus may be better able to receive economic development incentives in the form of special tax and other public policy concessions. In addition, large businesses may be better able to avoid state taxes by shifting income among their various subsidiaries in other states and countries, and they may be better able to pursue other tax planning strategies. If important differences are identified between the responsiveness of large and small businesses to state tax policy, then our research may help policymakers better target their economic development efforts. Results provide two key pieces of evidence concerning the relationship between state tax policy and small business growth. First, we find that higher state statutory sales and corporate income tax (CIT) rates, as well as the presence of a state throwback rule, are associated with lower small business growth rates. Second, we do not find consistent evidence that state tax policy influences large business growth, suggesting that large businesses can leverage tax incentives and use tax planning strategies to effectively avoid state taxes in ways that small businesses cannot. …