US states’ tax-and-spend policies hurt their neighbors

Ed Robinson | Nov 29, 2016

Sections Economics Public Policy

Collections Tax Policy

When the State of Illinois raised taxes in 2011, neighboring state Indiana put up gleeful billboard advertisements to attract business. “Illinoyed by higher taxes?” the ads asked. “Come to Indiana, a state that works.”

But research findings have some bad news for Indiana and elsewhere: rising taxes and spending in one state can have substantial negative effects on people in neighboring states, suggests a study by Chicago Booth’s Sam Peltzman.

The results add weight to the view that when state and local governments increase spending and taxes, there are negative consequences for the economies of border areas, Peltzman says. That’s true for border counties within a state that raises taxes, and about half the effect spills over to counties on the other side of the border, he finds.

Plight of border counties
Research suggests areas that rely on interstate business suffered in the wake of a 1 percent rise in a state’s taxes and spending.

Peltzman examined economies in neighboring states from 1975 to 2012. He measured employment levels, wages, and the number of businesses established after tax and spending policies were implemented.

He studied how fiscal-expansion policies affected the counties individually—and he looked at what happened when a simultaneous fiscal expansion occurred on both sides of a state border. The data consistently suggest that the economy of a border county shrank when its state’s taxes and spending increased, and local economies also shrank when the state on the other side of the border raised taxes at the same time.

The findings tend to support the argument “that larger state and local government is purchased at the cost of a smaller private sector,” Peltzman writes. He suggests that further research will identify what types of taxes and spending matter the most and which industries and other groups are hardest hit.