State Taxes and Spatial Misallocation

We study state taxes as a potential source of spatial misallocation in the U.S.. We build a spatial general equilibrium framework that incorporates salient features of the U.S. state tax system, and use changes in state tax rates between 1980 and 2010 to estimate the model parameters that determine how worker and firm location respond to changes in state taxes. We find that heterogeneity in state tax rates leads to aggregate welfare losses. In terms of consumption equivalent units, harmonizing state taxes increases worker welfare by 0.6% if government spending is held constant, and by 1.2% if government spending responds endogenously. Harmonization of state taxes within Census regions achieves most of these gains. We also use our model to study the general equilibrium effects of recently implemented and proposed tax reforms.