THE IMPACT OF STATE TAX STRUCTURE ON EMPLOYMENT: AN OPTIMAL TAX APPROACH

To address the question "does the mix of state taxes affect the employment in a state given a certain level of state revenue," an optimal tax model is developed. The objective of this model is to maximize employment at the state level. The model explicitly incorporates the state's budget constraint and the impact of tax changes on tax revenue by examining the supply side impacts of taxes on the respective tax bases. The results of the model give guidance of the employment maximizing mix of the state's taxes. It is found that the marginal impacts of the state's taxes on employment in relation to the impact of the taxes on tax revenue should be equal across taxes.; Econometric techniques are then used to estimate the required parameters to determine the impact of taxes on total employment, as well as employment in six industry types, and the tax bases using data from the fifty states for the nine year period 1984 to 1992. Econometric techniques are also used to assess whether the employment maximizing relationship currently exists within the states. While the results are mixed, it appears that in some cases the states are not currently structuring their taxes to maximize employment. In particular, it appears that a reduction in the marginal corporate tax rate offset by an increase in another type of tax, given the same level of expenditures would be of benefit. Potential avenues of future research are also presented.