The Effect of Market-Based Sourcing on Labor Outcomes

Abstract

This study examines how income tax sourcing rules affect business activity in U.S. states. As technology has enabled companies to provide services to consumers globally, a growing number of governments seek to tax service companies based on the customer location (“market-based sourcing”) rather than the location of the company’s labor and capital. Consistent with market-based sourcing reducing the tax cost of locating marginal labor in the state, I find that state adoption of market-based sourcing increases the total number of employees and total labor earnings in affected service industries by roughly 2 to 5 percent. I find indirect evidence that the effects are mostly attributable to business expansion rather than employee reallocation across states. Market-based sourcing does not seem to adversely affect state corporate tax revenues. This study provides timely insights for policymakers given increased adoption of market-based sourcing by U.S. states and related international proposals.

Keywords: Business Tax, State Government, Labor Markets

JEL Classification: E24, H25, H71