CEDS UNPAD

Determinants of States Tax Rate

The problem addressed mostly in tax and government spending study is the endogeneity problem between tax/spending and income or economic growth. Therefore, the efforts to find instruments for tax variable are very crucial. This paper investigates the factors that determine changes in state tax rates with the US dataset from 1960 to 1999. I use a time series and cross-sectional approach (panel data) complemented by the utilization of fixed effect and interaction variables technique in the OLS estimates. I find that demographic, economic, and political structure variables are important for the determination of the change in state tax rates. Special for political issues, this empirical information supports the common knowledge that Democratic legislatures favor higher tax rates compared to Republicans, both in state and federal levels. Last, this result will allow researchers to address endogeneity concerns about tax and spending policy by incorporating 2SLS estimation in the analysis of economic growth.

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