Broadening State Capacity: Fiscal and Mobility Consequences of the Introduction of the Income Tax

Abstract

We examine the fiscal and mobility consequences of the introduction of a major new tax, distinguishing between two effects: the effect of raising the tax rate, and the effect of moving from a zero to a non-zero rate. Drawing on archival data, we introduce a novel panel dataset of U.S.~states between 1900 and 2010. Our research design exploits the staggered introduction of the income tax across states, while accounting for the potentially selective timing of adoption. We find that tax broadening increased revenue and expenditure more in per capita terms than in absolute terms, with revenue per capita increasing by 15 percent in the long run. Furthermore, we find that the introduction of the income tax led to significant outmigration to non-income-tax states, particularly by high earners. Our main contribution is to show that the introduction of a new tax has an effect that goes above and beyond its effect on the net-of-tax rate, due to administrative costs, salience, or expectations. We find that the introduction of a new income tax of 1 percent induces the same outmigration response as increasing an existing tax from 1 to 10 percent.

Keywords: State Capacity, Institutional Reform, Taxation, Mobility, USA

JEL Classification: H11, H41, H71, N42, D78