The Effects of Regional Tax Incentives:

□지방정부연구□ 제7권 제3호(2003 가을) : 305∼318

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Dynamic General Equilibrium Simulation Study

지방세 혜택의 효과에 관한 연구:

동태 일반균형모델을 이용한 시뮬레이션 분석

Iksoo Cho(Nebraska Legislature, USA)

지방 경제를 활성화하기 위한 노력의 일환으로, 지난 20여 년간 미국의 각 지방정부들은 기업에 대한 세금혜택을 강화해 왔다. 이러한 조세정책은 정책결정자들에 의해 대단히 선호되어왔으나, 그 경제적 효과에 대해서는 경제학자들 간에 많은 논쟁이 있어왔다. 이 논문은 a dynamic CGE model을 이용하여 미국 네브래스카 주의 기업에 대한  조세감면혜택의 효과를 분석하였다. 2001년을 기점으로 하여, 향 후 7년 간, 매 년 $ 100 million의 기업 세금 감면을 시뮬레이션 한 결과, 네브래스카 지역의 투자는 $ 6,760 million 늘어났으며, 23,000의 일자리를 창출할 것으로 추정하였다. 이러한 경제적 성장은 세금감면의 비용인 조세지출의 약 200 퍼센트를 상회하는 지역 소득을 가져왔으며, 기업 세금감면에 의한 비용을 제외할 때 약 100 퍼센트의 추가적 소득을 가져왔다. 그러나 이러한 경제성장에 의한 추가적인 조세수입은 조세지출의 약 20 퍼센트에 머묾으로써 지방정부의 재정결손을 전부 보상 할 만큼 크지는 않다는 것을 보여주고 있다. 동태 일반균형분석에 의한 지방 조세정책의 분석은, 비록 경기 예측치로서 사용 할 수는 없지만, 정책의 장기에 걸친 효과의 방향과 크기를 보여 줌으로서, 정책 변화에 따른 여러 가지 경제적 함의들을 제시하고 있다. 이러한 결과들은 지방경제를 활성화하려는, 정책결정자들에게 유효한 지침으로 제시될 수 있을 것이다.

주제어 : 지방조세정책, 일반균형모델, 투자세금감면

Ⅰ. INTRODUCTION

The investment tax credit is a reduction in a firms tax liabilities by an amount related to its expenditures on equipment, and thus reduces the cost of acquiring assets. It can be introduced temporarily to stimulate investment as part of a countercyclical fiscal policy, or permanently as part of a strategy to enhance capital formation, raise labor productivity, and therefore speed longer-term economic growth (Meyer, Prakken, and Varvares, 1993). In the U.S., the investment tax credit was initially offered in 1962 by 　The Revenue Act of 1962　 and has been repealed several times in the last 30 years. The investment tax credit has currently been eliminated from the Federal tax code.

Since the U.S. federal government eliminated the investment tax credit from the tax code in 1986, almost every state in the U.S. has begun to provide its own tax incentives to enhance its ability to entice and retain businesses and their associated jobs. The number of states in the U.S. adopting investment tax credits increased from 27 in 1984 to 44 in 1997, and during the past few years, states have begun to replicate one anothers programs, with the result being that each offers a variation of nearly every possible tax incentive (Chi and Leatherby, 1997). The rivalry has become so intense that states find themselves at war with one another (Hamilton, 1994; Burnier, 1992; Burstein and Rolnick, 1991).

The Effects of Regional Tax Incentives: Dynamic General Equilibrium Simulation Study

□지방정부연구□ 제7권 제3호(2003 가을)

Incentive packages offered by regional governments focus not only on incentives for new capital formation but also on the creation of new employment within the region because 　creating jobs　is one of the most important concerns among policymakers who have the responsibility for promoting economic development in their regions. However, the effectiveness of investment tax incentives toward achieving this goal remains controversial.

There are hundreds of studies aimed at investigating the effects of regional tax incentives, in which various research methods (including the survey technique, the case study technique, the econometric models, and the general equilibrium models) are used. Batik (1991) concluded, through a comprehensive review on published papers during the 1970s and 1980s, that state and local tax incentives can have significant effects on regional growth. A state and local business tax reduction of 10 percent, not including a reduction in public services to businesses, probably increases business activity in the long run by 2.5 percent.

In contrast to Bartik, Lynch (1996) found that there is little empirical support for the hypothesis that tax incentives play a significant role in stimulating economic growth. He argued that tax incentives force state and local governments to cut back on the quantity or quality of public services because of the lost tax revenue. These reductions could damage the economy and could offset the positive effects of tax incentives on the economy.

Wasylenko (1997) also pointed out, through a review of recent econometric studies, that the results and the implications of each tax study varied and that a wide range of tax elasticity was reported, but he argued that, overall, tax incentives did not appear to have a substantial effect on economic activities in their respective regions. These inconclusive diversities in the effectiveness of regional tax incentives indicate that any specific regional tax study requires a specific analysis that concerns the sole economic conditions in the study area, and the distinctive properties of the tax incentive program with which the study is concerned.

The purpose of this paper, using a dynamic computable general equilibrium (CGE) model, is to investigate the effectiveness of a regional investment tax credit, especially an investment tax credit in Nebraska. Since the changes in tax policies generally affect nearly every aspect of the economy, the model for policy assessments should be sensitive to both a wide range and scale of policies and projects, and to dynamic structural changes of the economy in the long run. In order to capture its properties, the use of a dynamic general equilibrium model, rather than a static general equilibrium model or a fixed price model, is required. The dynamic CGE simulation in this paper provides the numerical impacts of tax incentives on the regional economy including the changes in state revenue, investment, employment and personal income.

The remainder of the paper is organized as follows. Section II introduces the program of a tax incentive provided the State of Nebraska that is a subject to be examined in this paper. Section III provides a brief overview of a CGE model and discusses investment behavior, dynamic formation and data. Section IV presents the design of the policy experiments and simulation results. Section V offers conclusions.

Ⅱ. EMPLOYMENT AND INVESTMENT ACT IN NEBRASKA

Since the Nebraska legislature enacted the Employment and Investment Growth Act, Legislative Bill 775 (hereafter referred to as LB775) in 1987, LB 775 has been a major tax policy to encourage businesses to remain and grow in Nebraska. Under LB 775, a performance based incentive plan, Nebraska has provided various tax incentives such as sales and use tax credits, employment compensation credits, investment credits, and personal property tax exemptions to qualifying firms, which could reduce or even eliminate the tax liability of firms' engaging in major investment projects.

The tax incentives were, therefore, expected to promote the creation of jobs and business investments. However, tax credits are only available to specific firms that meet the criteria for type and size of investment, as well as number of employees. The firms must meet the minimum required levels of employment and investment during the attainment period,　which includes the year of application and the succeeding six tax years. Table 1 summarizes the minimum requirements and the benefits of tax incentives.

During 13 years (1987-2000), 693 applications were received and 501 projects were activated. Two hundred ninety-six companies have reached the minimum required levels and have qualified to receive credits and/or sales and use tax refunds. Twenty-two of these projects have received all expected benefits and are completed. Through December 2000, qualifying firms have earned $1,102 million credit and used $755 million of credits to reduce income tax and sales/use tax.

Table 1. Summary of Benefits of Employment and Investment Growth Act

Minimum Requirements	Incentives
$3 million investment and 30 full-time employees	A refund of all sales and use taxes paid on purchases of qualified property at the project.

Table 1. Summary of Benefits of Employment and Investment Growth Act (Continued)

Minimum Requirements	Incentives
	Five percent tax credit on the compensation paid to the firms new or additional employees. Available for seven years;
	Ten percent tax credit on total investment in qualified property.
$10 million investment and 100 full-time employees	All of the above plus up to a 15-year personal property tax exemption on newly acquired:
	Turbine-powered aircraft or jets;
	Mainframe computers and peripheral components used in the project;
	Equipment used directly in processing agricultural products.
Investment in qualified property resulting in a net gain of $20 million with no increased employment.	Direct refund of all sales and use taxes paid on purchases of qualified property at the project.

Ⅲ. THE STRUCTURES OF THE MODEL

In 1998, Cushing and Cho (1998) developed a static Nebraska CGE model under contract with the Nebraska Legislature and reported the model and the documentation, Tax and Revenue Analysis in Nebraska (TRAIN), to the Nebraska Legislature. The TRAIN model is an adaptation of the Dynamic Revenue Analysis Model (DRAM) constructed by Berck, et al. (1996). It is a regional CGE model with a Social Account Matrix (SAM) data set, especially detailing government sectors in order to capture the sensitivity of government revenue and expenditure flows.

The dynamic TRAIN model used in this study is constructed along the line of a static TRAIN model. Since the dynamic TRAIN model succeeds to sectoral aggregation and behavioral specifications for representative agents from the TRAIN model, it keeps most of the properties of the TRAIN model.

1. Overview of the Tax and Revenue Analysis in Nebraska (TRAIN) Model

The TRAIN model is a CGE model that is a numerically specified general equilibrium model for policy evaluation. Keller (1980) points out that the difference between the Harberger model and The CGE model is twofold. First, there is a great difference in their degree of complexity; secondly, the models used for solving the equilibrium prices diverge. Whereas the Harberger model is based on simple two-sector models solved by analytical methods, the CGE model studies use numerical routines to solve for equilibrium prices, given a particular data set.

) A complete discussion of a classical CGE model for tax policy evaluation is provided in Ballard, et al. (1985). Shoven and Whalley (1984), and Pereira and Shoven (1988) provide excellent reviews on CGE modeling and dynamic CGE modeling, respectively.

The TRAIN model as a CGE model is a set of equations that describes the economic activities of consumers, producers, governments, and traders in the markets for factors of production, output, and net imports. In the model, the Nebraska economy has been aggregated into 72 distinct sectors in order to explicitly trace economic flows. These include 26 industrial sectors, 2 factor sectors, an investment sector, 9 household sectors, 33 government sectors and a rest-of-the-world sector.

Households face two decisions: how much goods and services they consume in order to maximize their utilities and how much labor they provide to the labor market. Firms determine how much input they each use to maximize their profit. Governments collect various taxes and spend funds for improving people's welfare. The model also specifies investment decision-making and the structure of foreign trade.

The model adapts the Cobb-Douglas formulation as consumers utility function with unitary income elasticities, zero cross price elasticities, and unitary own price elasticities. A firm produces outputs from the most effective combination of inputs including labor and capital in order to maximize profit. The functional form chosen for production is the constant elasticity of substitution (CES) function for primary factors of production and fixed-shares for intermediate inputs. Armington's CES formulation is adapted for foreign trade. With the assumption that products from different places competing in the same market are imperfect substitutes, Armington's CES function is known as a more realistic buyers behavior function. The population for each household type is a function of the existing population, increased by the natural rate and by the effect of net migration. And working population depends on the after-tax return to labor.

) A sectoral aggregation and behavioral equations of the TRAIN model are found in Cho (1999).

2. The Behavior of Regional Investment

In a national model, it is likely that a substantial fraction of any increased savings will translate into increased national investment. Lack of information about foreign firms and exchange-rate risk makes this a rational behavior. Incorporating the effects of current savings on the future capital stock and household income will produce a dynamic sequence of equilibrium periods. The volume of total savings in the national economy determines the total investment in many national-level CGE models.

However, regional savings, unlike in a national model, need not to translate into regional investment. There is one currency and ready access to firm-specific information in the United States, so capital markets in the United States are at the national level. Thus, additional regional savings are spread over the whole nation (Berck, et al., 1996). When Nebraskans save more than Nebraska investors want to use, excess savings flow out of the state. When the converse is true, savings flow into the state. Rational economic agents would not accept less interest on their savings from Nebraska investors if higher interest rates were available in other states or countries. Conversely, rational investors in Nebraska would not pay higher interest for the use of Nebraska savings if other states or countries offered lower rates. This difference between regional and national models should cause a lesser dynamic effect for a tax change in a region.

In the model, investment is determined by an investment function that is independent of regional savings. The level of regional investment is driven by rates of return in the region relative to the rest of the nation. In the study of investment tax incentives, it seems appropriate to treat the inflow of external savings as a residual that responds to the level of investment in the region since regions are highly open economies and investment funds appear to be geographically mobile in the United States.

Table 2. Structure of the Dynamic TRAIN

Period t				Period (t +1)
Endowment	Stage 1	Result of Stage 1	Stage 2	Endowments
Labor stock	Calculation of static CGE	After-tax Real wage	Labor migration	Updated labor stock
Capital stock		Prices of goods	Net investment	Updated capital stock
		Output level
		Rental price of capital

3. Dynamic Consideration

The Nebraska economy is characterized by an incomplete, sequential market structure in the dynamic TRAIN model. The key issue to formulating a dynamic model is how to incorporate the fact that different parts of the economic system adjust at very different rates. Robinson (1976) points out that there are two kinds of adjustment behavior to be considered. First, there are markets such as product markets in which prices and quantities adjust quickly and excess demands are reduced to zero within a relatively short period. The equilibria attained in these markets are Walrasian in nature. Second, there are markets such as factors markets in which excess demands or supplies can persist for an extended period. In those markets, adjustment takes multiple periods because of lagged responses of factor supplies, represented by labor migration elasticities and the adjustment coefficient in the investment function in the model.

Dynamic TRAIN has two different stages for incorporating these two kinds of adjustment behaviors. The first stage calculates the instantaneous adjustment of prices and quantities in goods markets, and the second stage calculates the lagged response in factor markets. This strategy is similar to the model presented in Robinson (1976), Ballard et al. (1985), and Seung and Kraybill (1999), and is schematically depicted in Table 2.

Static equilibria are sequenced through time to reflect changes in the economy's capital and labor stocks due to investment, and labor migration. Calculation of equilibrium in each period begins with an initial capital endowment in each sector and a labor endowment for the economy as a whole. (Seung and Kraybill 1999)

4. Data Collection

Since We assume that the initial condition of the economy is in equilibrium, We construct the model so that its equilibrium replicates observed data in the base year. We have chosen the fiscal year 2000-2001 (July 2000 through June 2001) as the base year. We construct the sets of data, which consist of a Social Accounting Matrix (SAM), a Capital Coefficient Matrix (CCM), and a miscellaneous data set. As the primary data set, the SAM is an extension of a traditional Input-Output model including income distribution, taxation, and consumption data, is a square matrix with balancing incomes and expenditure. CCM and other miscellaneous data provide some important parameters to solve the model.

The data for the industrial and household sectors in SAM are from IMPLAN (Impact Analysis for PLANing) and the data for the government sectors are obtained from various sources. A Capital Coefficient Matrix for Nebraska is aggregated and updated from a National Capital Coefficient Data Matrix provided by the U.S. Department of Commerce. The other critical parameters are the same as the parameters in the TRAIN model.

) The data sets for the base year and parameter specification of the model in this paper is consistent with the data sets and parameter specification of the TRAIN model as reported in Cushing and Cho (1998), and Cho (1999), respectively.

One important parameter for this analysis is the effective rates of the investment tax credit. Since investment tax credits in Nebraska are only available to particular firms and particular projects, We assume that the share of qualifying firms is set to the percentage of actual qualified investment in total investment for each industry. In the current investment incentives system, most investment in agriculture, primary resources, retail, health, and entertainment sectors is not eligible for tax credits. Therefore, We assume that all firms in those sectors are not eligible for tax credit. We estimate the

) Since the definition of investment for qualifying tax credit is different from the traditional definition of investment adapted to estimate total investment, this calculation is problematic. It requires further research to obtain an accurate parameter.

effective rate of the investment tax credit as the percentage of an actual investment tax credit over actual qualified investment.

Ⅳ. THE RESULTS OF SIMULATION

The model simulates the effects of increased investment tax credit without considering the reduction of public expenditures. We have chosen the fiscal year 2000-2001 as the base year and assume that the State would provide an additional $100 million each year for up to 7 years. This is equivalent to a 60% increase during 7 years in the investment tax credit rate in eligible industries. Using the Dynamic TRAIN model, We analyze the dynamic effects of the tax credit over 20 years, which are incentive periods (2002-2008) and non-incentive periods (2009-2020).

1. Fiscal Impact

The increase in investment tax credit lowers the after-tax rental rate of capital for eligible industries, which stimulates more capital investment and changes employment depending on the degree of factor substitutability. The changes in investment and employment then determine the level of domestic supply in each industry. This, in turn, determines the level of private income consisting of capital income and labor income. Finally it determines the level of tax receipts and revenue.

Table 3. Change in the Fiscal Condition of State Government

						(millions of dollars)
Year	2001	2002	2003	2004	2005	2006	2007	2008
Tax Credit Expenditure	0	-100	-100	-100	-100	-100	-100	-100
Additional Tax Collection	0	11.031	14.386	17.242	18.678	19.596	20.213	20.661
Revenue Surplus	0	-88.969	-85.614	-82.758	-81.322	-80.404	-79.787	-79.339
Year	2009	2010	2011	2012	2013	2014	2015	2016
Tax Credit Expenditure	0	0	0	0	0	0	0	0
Additional Tax Collection	10.732	7.449	4.724	3.437	2.679	2.202	1.899	1.690
Revenue Surplus	10.732	7.449	4.724	3.437	2.679	2.202	1.899	1.690
Year	2017	2018	2019	2020			Total
Tax Credit Expenditure	0	0	0	0			-700
Additional Tax Collection	1.538	1.538	1.326	1.247			162.142
Revenue Surplus	1.538	1.538	1.326	1.247			-537.858

Figure 1. Change in Tax revenue

Table 3 and Figure 1 demonstrate the dynamic effects in changed tax and revenue over 20 years. When beginning to provide tax credit, the additional tax collection is ten percent of the investment tax credit given in 2002, going up with a diminishing growth rate during incentive periods (2002-2008) to reach twenty percent in 2008, and then turning down sharply without tax incentives. Even though additional taxes are received, the public sector accounts experience a drop in revenue due to the tax expenditure.

The budget surplus (tax credit expenditure less an additional tax collection) is $88.969 million in 2002, reduced gradually by increases in additional tax collection to reach $79.787 million in 2008. During the non-incentive periods, the budget surplus is $10.732 in 2009 and $1.247 million in 2020 without tax credit expenditure. Total additional tax collection over the 20-year period is $162.142 million, generating the estimate of about 23 percent dynamic feedback effects and the budget surplus is $-537.858 million.

Table 4. Change in Capital Stock and Emplyment

						(millions of dollars)
Year	2001	2002	2003	2004	2005	2006	2007	2008
Capital Stock (millions of dollars)	0	579.552	695.534	775.021	821.008	850.397	870.915	886.626
Employment (jobs)	0	1,272	1,791	2,580	2,961	3,162	3,265	3,317

Table 4. Change in Capital Stock and Emplyment (Continued)

Year	2009	2010	2011	2012	2013	2014	2015	2016
Capital Stock (millions of dollars)	312.714	208.952	141.268	105.975	86.351	74.907	67.744	62.856
Employment (jobs)	2,048	1,527	746	368	166	58	0	-31
Year	2017	2018	2019	2020			Total
Capital Stock (millions of dollars)	59.206	56.254	53.724	51.468			6,760.48
Employment (jobs)	-47	-56	-59	-61			23,008

2. Impacts on Capital Stock and Employment

The primary impact of the tax credit is the stimulation of new investment made by savings and capital inflow from outside of Nebraska, which leads to an increase in the capital stock in the economy and changes in employment depending on the degree of factor substitutability. The economic impacts of investment tax credits indicate that producers can be expected to implement substitution of capital for labor as a first step. With reduced total capital payments, firms demand more capital and less labor until the marginal revenue product of each factor is equal to its marginal factor cost. Overall, however, the cost of doing business is reduced.

Since Dynamic TRAIN assumes perfect competition, domestic prices fall to domestic marginal costs. Exports increase, and imports decrease. Domestic output rises to meet demand, but with some of the initial cost-push deflation being lost. Rising output further increases the demand for capital and labor, and firms hire back more than their initial losses in staff. This dynamic process results in the immediate response of investment and capital stock and the lagged response of employment.

Table 4 presents dynamic impacts on capital stock and employment over 20 years. When beginning to provide tax credits, the capital stock and the rate of employment increases sharply in 2002, going up gradually during an incentive period. After terminating tax incentives, capital stock turns down sharply, but the number of employment shows the lagged response in labor demand. The results also show that after the incentives period, the tax credits sustains substantial economic effect for 5-7 years (2009-2015), then the effects gradually fade out.

) In economic theory, most economists agree that temporary tax incentives do not lead to a permanent increase in the capital stock. However, the period and the magnitude of the effects are controversial. In the CGE study, the key elasticities and formation of future expectation are critical to determine the period and the magnitude.

3. Income Impact

Stimulated by tax incentives, households are willing to offer more capital to business and to receive a higher percentage of available capital payments. As the economy grows, market wages rise slightly with increased labor demand when prices have fallen. Thus, real wages have risen. Households as owners of labor gain in the overall result: real wage increases and labor demand increases.

Table 5 and figure 2 present dynamic impacts on disposable income over 20 years. When beginning to provide tax credits, the disposable income increases $75.958 million in 2002, going up gradually during an incentive period to reach $184.281 million in 2008, and then turning down without tax incentives to $109.334 million in 2009, reaching $0.556 million in 2020. While the private sector makes its investment, substitution, supply and demand decisions gaining additional income from these business activities, State government accounts experience a drop in revenue with negative budget surplus.

After the negative budget surplus, the real　gain of tax incentives is demonstrated in Table 5 and Figure 2. At the beginning (2002), the compensated regional income is reduced $13.011 million due to a large negative budget surplus and lagged response of labor, and then the income recovers to $14.52 in 2003 and goes up to reach $120.066 million in 2009, then gradually fading out to $1.803 million in 2020. The overall disposable household income over 20 years is $1,324.627 million and the compensated regional income is $786.766 million.

Table 5. Change in Regional Income

						(millions of dollars)
Year	2001	2002	2003	2004	2005	2006	2007	2008
Household Disposable Income	0	75.958	100.134	141.655	162.403	173.963	180.487	184.281
Revenue Surplus	0	-88.969	-85.614	-82.758	-81.322	-80.404	-79.787	-79.339
Compensated Regional Income	0	-13.011	14.52	58.897	81.081	93.559	100.699	104.942
Year	2009	2010	2011	2012	2013	2014	2015	2016
Household Disposable Income	109.334	85.994	45.748	26.026	15.160	9.096	5.613	3.547
Revenue Surplus	10.732	7.449	4.724	3.437	2.670	2.202	1.899	1.690
Compensated Regional Income	120.066	93.443	50.471	29.463	17.830	11.298	7.511	5.237
Year	2017	2018	2019	2020			Total
Household Disposable Income	2.278	1.466	0.928	0.556			1,324.630
Revenue Surplus	1.538	1.538	1.326	1.247			-537.858
Compensated Regional Income	3.816	2.887	2.254	1.803			786.766

Figure 2. Dynamic Effets of Income and Revenue

V. CONCLUSION

In this study, I employed a dynamic CGE model to consider the effects of regional tax incentives, specifically an investment tax credit in Nebraska, with an emphasis upon revenue and income effects in the long run. Although investment tax incentives are one of the most popular tools among policymakers to improve the climate of the regional economy, the effectiveness of investment tax incentives toward achieving this goal remains controversial.

The simulation is designed to provide an additional $100 million each year for up to 7 years and to analyze spin-over effects over 20 years. The results show that after the incentive periods, the tax credit sustains substantial economic effect for 5-7 years and then, the effects gradually fade out. The overall economic effect of the tax credit on capital stock and employment over 20 years is $6,760 million and 23,000 jobs, respectively. The overall disposable household income gained is about 200 percent of the initial tax expenditure, and the compensated regional income gained is about 100 percent of the initial tax expenditure. Meanwhile, state government accounts experience a drop in revenue with negative budget surplus because additional tax collections by a spin-over effect just offset 20 percent of tax expenditures over 20 years.

This study demonstrates a long-run implication of the changes in regional tax policy through the CGE methodology that allows dynamic interaction among different sectors and agents within the economy. Even though the numerical results should not be interpreted as forecasting values, the directions and the magnitudes of the impacts of the policy changes provided by the simulation would be a valuable guide to regional policymakers who seek a way to improve the conditions of the regional economy.

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조익수(曺益銖) : 전남대학교 지역개발학과 및 동 대학원 졸업. 미국 University of Nebraska-Lincoln에서 경제학 전공으로 박사학위(General Equilibrium Analysis of Investment Tax Credit in Nebraska, December 1999)를 받고, 현재 Legislative Fiscal Office, Nebraska Legislature에서 재정연구원 (A Revenue Economist)으로 재직 중임. 주요 관심분야는 지방세 및 지방재정, 그리고 지역경제이론 등이다. 최근 발표된 논문으로 □Does State Investment Tax Credit Increase State Investment?□ 가 있다.<E-mail : ischo119@yahoo.co.kr/논문접수일: 2003.9.3/심사완료일: 2003.10.16>