A Regional Tale of Two Income Taxes

Abstract

This study evaluates the reporting of income as taxpayers may attempt to take advantage of the difference between the tax rates on personal and corporate income. In deriving the estimable equation, this analysis models regional economic activity within a dynamic macroeconomic framework with various government revenue sources and multiple expenditure categories. In addition, the model incorporates income shifting with convex adjustment costs. The sample includes the 48 contiguous U.S. states with annual observations ranging from 1977 through 2008. The findings suggest state personal income as a share of output grows the fastest when taxing personal income at a lower top marginal rate than corporate income and as the degree of income tax integration diminishes. The findings are consistent with the hypothesis that tax rate differentials induce economic agents to shift reported income into the relatively low taxed income.