Business Climate,Taxes,and Economic Development

Abstract

This article reviews the treatment given to state and local fiscal policy by modern business climate studies and contrasts it with research findings. Empirical evidence on the impact of tax differentials on economic growth has undergone major changes in recent years. Tax rates, when observed in isolation, are now widely believed to have a negative impact on state and local economic growth. This shift in consensus lends support to the major business climate studies that assign a prominent role to taxes. Unfortunately, most current business climate studies are too simplistic to provide a useful guide for economic development policy. In particular, the tax variables used in the studies are overly aggregative and government expenditures are virtually ignored. By contrast, recent empirical research that examines both sides of the budget and utilizes econometric analysis provides information that has the potential to enhance the efficiency and flexibility of economic development strategy.