Taxation, Substitution, and Industrial Location

Abstract

The threat that high taxes in a region might drive out or repel industry has traditionally worried those responsible for the tax policies of state and local governments in the United States. More recently, the possibility that subsidies might attract industry has led some state and local governments to engage in various forms of subsidization of industry, including tax exemptions, and has given rise to numerous studies of the effects of taxes and subsidies on the location of industry. These studies have used such varied techniques as interviews, econometric analysis, and comparisons of tax liabilities in different states in their attempts to assess the sensitivity of industrial location to tax and subsidy policies.1 But while these studies have undoubtedly shed some light on this complex question, most of them have been rather ad hoc descriptions of the potentially important determinants of the regional location of industry, including rough estimates of the relative importance of taxes and subsidies. Lacking explicit theoretical foundation,2 they can be of only limited value in specifying under what conditions, in what manner, and to what extent fiscal variables might be expected to influence industrial location. The present paper is an attempt to fill this theoretical void in the literature on the locational impact of tax policy. A general equilibrium neoclassical model is used to spotlight several important determinants of the sensitivity of industrial location to various general taxes levied in only one