Getting What You Pay For: The Case of Southern Economic Development

Abstract

For the past fifty years, states of the American South have been competing with one another in order to recruit businesses to locate within their borders. While previous research has focused on assessing the short-term success of a tax-based recruitment plan, this paper addresses an important gap in the literature by looking at the long-term consequences that such a development policy can impose on a state’s industrial structure. By incorporating the role of firm mobility, this paper demonstrates that at the state level, the effect of lowering the corporate income tax on the factor intensity of a state’s manufacturing industries is theoretically ambiguous because it is dependent on the type of firm that finds it easier to move. Using historical data from 1957-1992 and a dynamic, partial adjustment model, this paper establishes an empirical link between low corporate tax rates and labor-intensive manufacturing industries, thereby suggesting that a low-tax policy is encouraging the immigration of footloose, laborintensive firms. Moreover, the paper finds that the labor used tends to be of an unskilled (production) nature, even as the national trend is to substitute away from unskilled labor into skilled labor.

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