Tax Avoidance and Business Location in a State Border Model

Previous studies have struggled to demonstrate that higher taxes deter business activity. We revisit this issue by estimating the effect of changes over time in cross-border differences in state tax conditions on the tendency for new establishments to favor one side of a state border over the other. Identification is enhanced by taking account of previously overlooked reciprocal agreements that require workers to pay income tax to their state of residence as opposed to their state of employment. When reciprocal agreements are in force, higher personal income tax rates lure companies from across the border, while corporate income tax and sales tax rates have the opposite effect. Where reciprocal agreements are not in place, the results are largely reversed. These patterns are amplified in heavily developed locations, and differ in anticipated ways by industry and corporate/non-corporate status of the establishment. Overall, results strengthen the view that state-level tax policies do affect the location decisions of entrepreneurs and new business activity, but not in a way that lends itself to a one-size-fits-all summary.