Greatest Research Hits of 2019

Tax incentives, tax-induced behaviors, issues surrounding income inequality -- our annual review of this year's National Bureau of Economic Research working papers offers information and insights on issues and policies being debated at the state capitol.

As is our custom in the year’s last issue of Fiscal Focus, we take a moment to look back on “the year that was” in the National Bureau of Economic Research’s Working Paper series.   Once again we find that incomprehensible mathematics and turgid academic prose offers important information and useful insights on many issues and policies being debated at the state capitol.

Tax Incentives, Innovation, and Entrepreneurism

The devil is in the angel’s details. That’s the conclusion of a study examining the relationship between angel investor tax credits and entrepreneurship.[1]    Examining angel investor credit programs across the country researchers found no measurable effect on local entrepreneurial activity or beneficiary company outcomes.  The problem?   State programs often failed to screen out financially unconstrained firms.  Over 90% of beneficiary companies fell into one of three categories: 1) the company had previously raised external equity; 2) a corporate insider received the credit; or 3) the company was not in a high growth sector.  One third of beneficiaries included an investor receiving a tax credit who was an executive at the company.  Moral of the story is to manage eligibility carefully, otherwise it can become an angel tax arbitrage program.

Research and development credits received a fair share of attention this year.   These have long been generally considered the most economically justifiable forms of favorable tax treatment because of positive spillover effects on the rest of the economy.   Which raises the question, have these spillover effects changed over time?[2]   Replicating a previous analysis to include 15 years of additional data, researchers found the marginal social return to R&D now exceeds the marginal private return to R&D by a factor of four -- compared to a factor of three in the original investigation.

How does corporate R&D impact labor?  Does it increase worker retention by creating new internal job and career opportunities or does it lead to departures to new and growing firms?   Does it create new marketable skills and job options for workers or lead to unemployment by making labor and skills obsolete?   These questions were examined in a study of corporate R&D and labor mobility in 31 states.[3]   Researchers found no effect on worker retention, employment loss, or movement to other companies.   Researchers did find, however, that R&D increased employee departures to new start-ups that are venture capital backed, high tech, high wage, and in different sectors than the parent firm.

R&D credits have been strongly linked to innovation, but do state R&D credits effect the rate of formation and growth potential of new businesses?  In a study of 25 states over a 20-year period researchers found “striking evidence” that state R&D credits have a long-term impact on the quantity and quality of entrepreneurship in a region.[4]  Policy patience, however, is warranted.  While state-level R&D credits have little to no effect on new firm formation in the first few years, researchers found these incentives led to a 20% increase in the quantity and quality-adjusted quantity of entrepreneurship over a ten-year period.

Taxes and Behavior

Determining if and how taxes make people behave differently has always been research catnip to academia.   A couple of contributions caught our attention this year. The first, is an examination of the ultra-wealthy in response to estate taxes (that was also flagged by the Star Tribune in an editorial page commentary.)[5]  Researchers looked at the mobility of the Forbes 400 richest Americans to examine their sensitivity to a change in federal estate tax law which made the existence of state-level estate taxes far more economically relevant.[6]  Perhaps unsurprisingly, the number of Forbes 400 individuals in estate tax states fell by 35% compared to non-estate tax states.  The fascinating part of the study examines the cost-benefit analysis for having an estate tax modeled on the current federal estate tax.   With respect to Minnesota, researchers concluded the cost/benefit of having an estate tax depends on how sensitive the “very wealthy” are to estate taxes compared to the “ultra-wealthy.”  If we assume the very wealthy relocate at the same rates as Forbes 400 billionaires, the cost of having a Minnesota estate tax exceeds the benefits by 40% reflecting $4.2 billion in lost revenue (present value).   On the other hand, if we assume the very wealthy relocate at only half the rates of the super-rich, the benefits of having the tax exceed the cost by 41% reflecting a $5.1 billion present value revenue gain.      

The analysis does come with two major caveats: 1) results do not factor in indirect effects like reduced in-state investment, charitable giving, etc.; and 2) the impacts on sales, property, and other tax revenues are not included.  Nevertheless, the study suggests future behavioral responses to state estate taxation is an important question with potentially major state fiscal implications.

The behavioral impact of increasing the top rate of high-income earners was the focus of a study looking at the impacts of California’s tax increase of up to 3 percentage points for high income households in 2012.[7]   Researchers concluded an additional 0.8% of the residential filing base exposed to the new top bracket moved out of California in 2013 (above and beyond baseline departure rates).   When combined with declines in reported income among top bracket “stayers,” researchers concluded migration and other behavioral responses eroded 45.2% of the windfall tax revenues from the reform.

Those interested in expanding the universe of sin taxes for both revenue and public health purposes are now sticking a policy straw into sugar-sweetened beverages.   A study examined the impact of Oakland’s one cent per ounce tax on sugar-sweetened beverages on retail prices, product availability, purchases and consumption.[8]   Researchers found about 60% of the tax was passed on to consumers in the form of higher prices.  Researchers also found a small decline in the volume of beverages purchased, some evidence of an increase in purchases outside of the city limits and evidence of some increase in general shopping by Oakland residents outside of the city.  With respect to health concerns, they found no substantial changes in consumption for either adults or kids.

Equity, Income Growth, and Income Inequality

A few interesting papers offered some bigger picture perspective and history on this influential set of issues surrounding state tax and fiscal policy.    Research this year offered an important historical perspective on a topic that tends to get overlooked in income inequality debates--the considerable contributions government tax and redistributive policies have made in addressing these matters.[9]    In the study, researchers from the U.S. Congress Joint Committee on Taxation, the Council of Economic Advisors, and Cornell University calculated and compared nearly 60-year trends using the most restrictive measure of income (“market income of individuals” which includes gross wages, salaries, farm income, self-employment, pensions, interest, rent, and alimony ) with the most expansive measure of income (household size-adjusted, post-tax, post-transfer market income + in-kind income + the value of Medicare, Medicaid, and employer-sponsored insurance).  The former is the basis for the oft-cited concerns over stagnating middle class and growing income inequality; the latter is a more complete perspective on economic well-being.

Using the market income measure, real median income growth since 1959 has increased 23%.  The lowest population quintile has experienced a 75% decline in income growth while the top quintile experienced a 155% increase in income growth.  In stark contrast, switching to the most expansive measure of income, median income growth since 1959 is 154%.    The lowest quintile experienced a 262% increase income growth while the top quintile experienced a 187% increase. 

Turning to measures of income inequality (Gini coefficients), similar results were found.  Using a market income basis, income inequality in the U.S. has risen steadily at every business cycle peak over the last 60 years, increasing 22% over that period.   But using the more all-encompassing income measure income inequality in the U.S. declined by 2.5% and is 42% less than the market income-based income inequality measure.   The authors conclude that excluding the impact of government taxes and transfers “substantially understates the impact of government policies in offsetting stagnant median market income and the rise in market income inequality since 1969 . . . While over this period the rich got substantially richer, so did poor and middle class Americans.”   For a state like Minnesota, ranked second in the nation in health and human service spending and featuring some of the nation’s most generous and broadly accessible income support programs, this is a finding worth keeping in mind the next time the fairness rhetoric heats up.

Which of these programs provide some of the biggest bang for the budget buck?  That was the focus of a comparative welfare analysis of 133 U.S. policy changes pertaining to social insurance, education,  job training, taxes, and cash and in-kind transfers over the past half century.[10]  Researchers created a “marginal value of public funds” measure (MVPF) based on the ratio of benefits to net cost inclusive of long-term impacts to the government’s budget.   Echoing and confirming research findings and public testimony often heard here in the state, health and education programs targeting low-income children had the highest spending MVPF scores--some paying for themselves through additional tax collections and reduced transfers.    Interestingly, the 1986 Tax Reform registered an MVPF of 44.3 far exceeding most spending programs.

How do people get rich in the 21st century?  That was the focus of a study examining top earners and their characteristics.[11]   Researchers concluded it’s from human capital effort, rather than financial investment, primarily from owning/managing mid-size companies employing tax-advantaged pass through business structures.   The increased use of pass through entities -- in which business income gets disguised as labor income--has distorted understanding of how money is earned.   Researchers found “wage” income dominates up to the 99th percentile of income distribution.  More than 70 percent of the “human capital rich” are under 60 and typically own companies in skilled service industries.  Interestingly, at the top 0.1 percent above the 99.9th percentile, the typical company is a large law firm, beverage distributor, or auto dealership.   It’s likely the one and only time such an eclectic trio of businesses will ever be grouped together.

FOOTNOTES


[1] Howell and Mezzanotti, “Financing Entrepreneurship through the Tax Code: Angel Investor Tax Credits” NBER Working Paper No. 26468, November 2019

[2] Lucking, Bloom, Van Reenen, “Have R&D Spillovers Changed?”  NBER Working Paper No. 24622, May, 2019

[3] Babian and Howell, Entrepreneurial Spillovers from Corporate R&D: NBER Working Paper NO. 25360, July, 2019

[4] Fazio, Guzman, and Stern, “The Impact of State-Level R&D Tax Credits on the Quantity and Quality of Entrepreneurship” NBER Working Paper 26099, July, 2019

[5] “Taxing the rich pays — to a point, estate tax study shows” Doug Tice, Star Tribune, November 1, 2019

[6] Moretti and Wilson, “Taxing Billionaires: Estate Taxes and the Geographic Location of the Ultra-Wealthy” NBER Working Paper No. 26387, October, 2019

[7] Rauh and Shyu, “Behavioral Responses to State Income Taxation of High Earners,” NBER Working Paper No. 26349, October, 2019

[8] Cawley, Frisvold, Hill, and Jones, “Oakland's Sugar-Sweetened Beverage Tax: Impacts on Prices, Purchases and Consumption by Adults and Children NBER Working Paper No. 26233 September, 2019

[9] Elwell, Corinth, and Burkhauser, “Income Growth and its Distribution from Eisenhower to Obama: The Growing Importance of In-Kind Transfers”  NBER Working Paper No. 26439, November, 2019

[10] Hendren and Sprung-Keyser, “A United Welfare Analysis of Government Policies,” NBER Working Paper No. 26144, August, 2019

[11] Smith, Yagan, Zidar, and Smith, “Capitalists in the 21st Century, NBER Working Paper No. 25442, June, 2019