1.
Economics of the Southwest
By: Greg Palmer and Michael Broughton
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2. Table of Contents
1) Introduction
2) Tax Climate
a)Tax Climate Ratings
b)Professor Edward Prescott’s Research
3)Economic Outlook
a)Econometrics Analysis of Taxes
b)California Outlook
c)Texas Outlook
4)Growth of other non­CA states
a)GDP
b)Labor Forces
5)Conclusion
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3. Introduction
The southwest region of the United States has quite a rich economy and houses
roughly a quarter of the entire US GDP​13​
. We contend that these states place policies
and taxes that influence the business transactions that happened in these states. We
are analyzing the states of the region and how government, taxes, policies, and
regulations in one state have a very significant effect in the other areas of this
economically dense region.Our main focus will be the competition of jobs between
California and Texas.The rationale behind such a focus is to look at the difference
between the different economic viewpoint these two states harbor.
Our focus was narrowed into multiple sections in order to make sure that we
address the different problems as well as counter arguments where they are necessary.
The first of these will cover the findings of Professor Edward Prescott, an ASU
Professor, during his research that resulted in him receiving the Nobel Prize in
Economics.
We then changed gears and decided to focus on the econometrics reports that
came about the effect taxes have on wages, employment, and capital.These reports
help analyze the many issues that taxation brings to an economy.These papers illustrate
the problems that many supply side and free market economist bring up when
discussing the weakness of a state controlled government.
The last portion of our paper is dedicated to looking at the other states in the
southwest and how well the are doing.This section will also focus on how the Great
Recession affected these other states during these tumultuous times.The labor force will
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4. also be evaluated so as to determine the movement and projection of future
employment locations.
Lastly, we will reference a supply and demand graph in order to show what
happens when certain fiscal policies are put in place.
Tax Climate
Many economist believe that one of the main contributing factors to the
movement of jobs out of California is the anti­business climate perpetuated by higher
taxes. According to The Tax Foundation, which rates each state based on multiple
criteria and then gives the state a overall rating,Texas is consistently in the top ten best
states to do business whereas California is consistently in the bottom ten.The Tax
Foundation gives an overall rating based on the ratings of multiple subsections such as
state income tax and business taxes however that does not mean that the specific state
in question needs to have the absence of one of the major taxes in order to make the
top ten.The Tax Foundation states “But this does not mean that a state cannot rank in
the top ten while still levying all the major taxes.Indiana and Utah, for example, have all
the major tax types, but levy them with low rates on broad bases.​14​
”
The Tax Foundation lists the reasons for many of the bottom ten being ranked
where they are as stated, “The states in the bottom ten suffer from the same afflictions:
complex, non­neutral taxes with comparatively high rates.New Jersey, for example,
suffers from some of the highest property tax burdens in the country, is one of just two
states to levy both an inheritance and an estate tax, and maintains some of the worst
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5. structured individual income taxes in the country.​14​
” The Tax Foundation bases their
information off of the structure of the state’s tax system.From this information, we can
gather that California performs poorly in almost every category except Property Tax and
Unemployment Insurance Tax.The supply and demand graph shows us that as marginal
costs are increased, through taxation, the point where producers will supply the goods
and services moves to a lower quantity with a higher price​14​
.
The Tax Foundation states that although taxes are a piece of the reasons behind
a business decision, they the swiftest way to impact a competitive industry.The Tax
Foundation goes on to state that the US Department of Labor finds more job relocations
are to other states in the United States rather than to a foreign nation such as Canada.
The Tax Foundation state that if law­makers were more concerned with jobs going from
one state to another state rather than placing much of their focus on the transfer of jobs
to other foreign entities that the state in question would be in much better shape ​14​
.
An example of moving labor out of California can be found with the Intel
placement of a multi billion dollar chip facility into Arizona. One of the reasons behind
this is the high corporate tax rate in California compared to Arizona.This is one of many
examples of business moving to a laissez faire business environment which in turn
allows them to stay focused on business instead of taxes and regulators.
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6. Professor Edward Prescott’s Research
The economic study written by ASU’s Professor Edward Prescott, states that the
government cannot create a “perfect result” in regards to taxes because businesses will
always prepare for the future.Another reason he claims is that the government cannot
commit to a specific tax because if they do that in order to garner more in tax revenue
then the businesses will allocate resources differently resulting in lower taxes than
expected and a worse condition than under zero tax.His analysis was an incredible
contribution to the economic community which has influenced how economist,policy
makers,and government think about business cycles​11​
.
Professor Prescott has also written articles for the Wall Street Journal where he
talks about the effect of tax rates on the labor market and the number of hours worked
per capita.His article states that as taxes increase, the incentive to work falls which can
be shown through evaluation of the Netherlands, France, and Germany; the former
being a decrease in tax leading to more working incentive.His argument hinges on the
fact that as marginal taxes increase, the trade­off between leisure and work becomes
more in favor of leisure due to decreasing marginal returns(PrescottandOhanion)​10​
.
His analysis does not stop there however, he then reveals that in mainland
Europe, only one company formed between 1976 and 2006 reached success
comparable to Apple, Microsoft or many of the largest corporations in the United
States​11​
. He asserts that this is attributed to the convoluted regulation and higher tax
rates inhibit the entrepreneurial sector of the economy.His claim goes further that unless
we stabilize or lower the tax rates present in the United States right now we will not be
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7. able to attract entrepreneurs(PrescottandOhanion).His argument then concludes with
the following statement regarding entrepreneurship, “We have lost more than three
years of growth since 2007, and our underachievement will continue unless
pro­productivity policies are adopted and marginal tax rates are stabilized or lowered to
prevent a decrease in work effort across the board​12​
.That means lifting crushing
regulatory burdens such as those imposed by Dodd­Frank, and it means reforming
immigration policies so that we can substantially increase our base of entrepreneurs by
attracting the best and brightest creators from other countries. Economic growth
requires new ideas and new businesses, which in turn require a large group of talented
young workers who are willing to take on the considerable risk of starting a
business.This requires undoing the impediments that stand in the way of creating new
economic activity—and increasing the after­tax returns to succeeding.​12​
”
One of the many aspects of Professor Prescott that is critical in understanding the
dangers of government intervention was his analogy to the Great Depression where
working hours per capita slumped by more than twenty five percent and the decrease in
the overall GDP growth of the nation relative to trend is startling​10​
.Free Market
Economist have stated that a decrease in productivity as well as efficiency hampers the
economic activity of the nation.The article contends that unless we change this and start
allocating resources to the highest uses in society, that economic growth will continue to
slump and become stagnant which will decrease the overall living standards in the
nation.
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8. Tying this into our argument regarding taxes, we find that by providing a more
business friendly environment, states are able to attract businesses from other areas
resulting in higher productivity and efficiency.This may be the single most important
piece of evidence supporting the argument that taxes have a heavy influence on the
activity in a state.We conclude this section with a relationship analogy used by Steven
Moore,the head Economist for the Heritage Foundation, regarding the argument that
taxes played no part in the decision of Toyota to move to Texas, “​The problem is me,
not you, California. But when the one who’s walking out the door says this, it’s always
really about you.​6​
”
Econometric Model Analysis of Taxes
The Beacon Hill Institute for Economic Research developed a dynamic
econometric model for how taxes affect economic issues such as tax revenue,
wages,employment, and stock capital.This model called (STAMP) State Tax Analysis
Program Management has looked at how taxes has affected the state of Texas.In the
first model the dependent variable is a log function looking at the number of jobs in the
economy.This model states that for every 1% increase in government transfers equates
to a decrease in the number of jobs by ­.1342 % holding everything else constant.
Government Transfers include but are not limited to welfare,social security, subsidies for
businesses, and Medicare​1​
.Economic Theory states that people respond to incentives
and since government transfers are free it creates a disincentive to work.This
Econometric Model supports that that economic theory with a negative coefficient that is
statistically significant for a negative coefficient for government transfers.Also in this
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9. econometric model nonlabor costs,sales tax, and the cost of capital all have a negative
coefficient associated with it.
The second econometric regression that Beacon Hill ran is using the log of wage
rate as the dependent variable In this regression if you increase government transfers
by 1 % you will see a .0190% increase in wages holding everything else constant​1​
. As
Harvard Economist George J. Borjas states that,”The definition of the reservation wage
implies that the person will not work at all if the market wage is less that the reservation
wage, and the person will enter the labor force if the market wage exceeds the
reservation wage.​2​
”This econometric study supports this notion that workers will need to
be paid above what they would be receiving from government transfers in order to be
incentivized to work.The reservation wage is driving people out of the workforce and
decreasing labor supply again.
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10.
In the last econometric regression that Beacon Hill ran they used the log of stock
capital as the dependent variable.This model states a 1 % increase in the cost of capital
holding everything else constant will decrease the stock of capital used by .0309%. This
model states that if you increase property and sales tax that therefore makes capital
more expensive than businesses will take their business outside to more business
friendly states​1​
.
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11. California Outlook
California’s economy is growing at a rate that is slightly worse rate compared to
the rest of the country.California’s economy dropped by 1.4% in 2013 and ended the
year at 8.3% which is slightly higher than the rest of the country which ended at 6.6%
according to Wells Fargo.The main sectors of the California Economy are the tourism,
technology, and retail sectors that account for a large portion of the economy. Wells
Fargo expects the unemployment to drop even further with manufacturing and
construction jobs in demand.In January of 2014 home prices had increased by 20.3
percent from a year ago and the median price of a home increased by 22.1 percent
from a year ago​15​
.
Texas Outlook
Texas Economy created 3.2 % jobs in 2014 which is better the rest of the United
States which grew at a rate of 2.2 % in 2014.The Texas Unemployment rate which is at
5.2 percent is also lower than the the average in the rest of the United States. Texas
housing starts are up 24.9% from last year.Furthermore,Texas exports are up 10.4 %
higher than last year.Manufacturing jobs are the largest part of the Texas Economy​7​
.
GDP
The economic growth of the state is the best indicator of business health in that
area.California, which has an enormous GDP by any standard has slowed down in
recent years and suffered a tremendous decline in GDP during the Great Recession.
However,Texas on the other hand only saw a slight decline of less than 1% during the
period of the Great Recession.This is attributed to the ability of companies in Texas to
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12. compete with companies in California much easier and this allows companies in Texas
greater margins to deal with recessions.Along with this, California is the only one of the 5
states that has been unable to attain a 5% growth since 2001 as shown in the following
graphs. The previous information and the following graphs are based on information
gathered from the St Louis Fed, placed into excel, then graphed on a single set of
axes​10​
.
As is clearly shown from the graph, California has the highest GDP of the states
in the Southwest however, has had slower growth in recent years than multiple other
states despite receiving more than ⅔ of all the venture capitalist investments in the
country​2​
.This is a serious issue when nearly twenty three billion dollars is invested in
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13. California startups in only the first three quarters of 2014 compared to Texas who
received less than one billion or around four percent that of California yet Texas is still
able to attain a higher growth rate in their GDP.All of this clearly leads to the assumption
that California’s Economy has slowed due to many factors and one of the many reasons
that they are able to continue growing at that slow rate is because of the of cash into
silicon valley based companies in the tech industry.​13
Labor Force
The Labor Force and the migration of people to different states in the union, we
find that Texas has an unemployment nearly fifty percent less than California’s as well as
four times the job growth of California.Along with these claims, Stephen Moore
concludes that California is losing net taxpayers every year and that Texas salaries are
increasing at higher rates than California.​6 ​
One Forbes article claims that more than
three percent of Los Angeles labor force has left in the last ten years which is more than
Detroit, one of the picture examples of an economically crippled city​9​
.
By using a supply and demand graph, we are able to see the shift in the supply
curve consistent with an increase in taxes which lowers the quantity supplied and
demanded at a higher price indicating that as it approaches a level of tax that is a heavy
burden, everybody loses to an extent whether it be through higher prices or lower
production for businesses which decreases the labor needed to produce the good. All of
this is a negative for the economy and therefore we are able to conclude that the
increase in taxes not only affects the businesses in the region but also the labor force
resulting in a larger loss than anticipated.
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14. .
Conclusion
Daniel J. Mason an economist from George Mason University has compared
California to the bureaucratic nation of Greece.He makes that comparison based off
similarities in the high tax rates and the corrupt government.California is making itself the
role model along with the city of Detroit on how to push away talented people.The
opportunity cost of doing business in California is so great that it is hard to see how the
state will survive in the future​5​
.
David Henderson an economist at the Hoover Institute found out that if you make
one million dollars in the state of California, then you will owe $88,000 dollars of state
income tax.This figure was calculated before proposition fifty four was put in place. After
proposition fifty four was put into place that tax figurel increased by an additional 17,500
dollars, to make the final figure 107,500 dollars.You could save an additional 107,500
dollars just by moving to another state such as Texas, Nevada,or Florida​8​
.This number
does not account for the high cost of living in California.
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15. Furthermore to prove that high taxes and regulation are forcing people and
businesses to leave the California as quickly as possible we can look at interstate
migration numbers. California lost 27 billion dollars in income between the years
1999­2009, while Texas made 16.6 billion dollars, Nevada made 980 million dollars, and
Florida made 70 billion dollars during that time period.All three of those states have one
crucial thing in common and that is no state income tax​4​
.
As Professor Prescott has clearly illustrated throughout his illustrious career is that
labor supply is highly responsive to tax rates.The battle of the southwest for businesses
has clearly illustrated Professor Prescott’s findings.California has many natural
advantages over many bordering states, its a shame that California’s advantage is being
squandered by a greedy bureaucratic government.
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16. Citations
1 ​http://www.beaconhill.org/BHIStudies/TexasSTAMP299/texas_summary.html
2
blogs.wsj.com/venturecapital/2014/10/17/interactive­map­where­the­venture­capital­dollar
s­ are­going/
3 Borjas, G. (2013). ​Labor economics​ (6th ed., p. 41). Boston: McGraw­Hill/Irwin.
4 ​http://www.cato.org/blog/krugmans­gotcha­moment­leaves­something­be­desired
5 ​http://www.cato.org/blog/will­last­job­creator­leave­california­please­turn­lights
6 http://dailysignal.com/2014/05/08/california­leavin­businesses­politicians­state­denial/
7 ​http://www.dallasfed.org/assets/documents/research/indicators/2014/tei1411.pdf
8 ​http://econlog.econlib.org/archives/2012/11/californias_laf.html
9​http://www.forbes.com/sites/dalebuss/2014/04/30/texas­v­california­this­aint­over­when­t
oyota​ ­leaves/
10 ​https://www.minneapolisfed.org/research/prescott/papers/LaborSupply.pdf
11 ​http://www.nobelprize.org/nobel_prizes/economic­sciences/laureates/2004/advanced­
economicsciences2004.pdf
12
http://online.wsj.com/news/articles/SB1000142412788732446930457814279085176714
4
13 ​http://research.stlouisfed.org/fred2/
14 ​http://taxfoundation.org/article/2015­state­business­tax­climate­index
15
https://www08.wellsfargomedia.com/downloads/pdf/com/insights/economics/presentation
s/ California_Economic_Outlook_03052014.pdf
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17.
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