and Updates on Current Issues
tax hike from 5% to 6% would destroy 99,000, cut capital by $8.8 billion
24, 1997, the Ohio State Supreme Court ruled that funding for poorer
school districts must be brought closer to the statewide average. This
ruling will entail additional state spending of about $1 billion. Two
proposals for raising the new funds have emerged. One proposal would
increase the state sales tax from 5% to 6%. A second proposal would
freeze or cut spending on other government programs and use money from
the state budget surplus.
to an econometric analysis performed by the Beacon Hill Institute, the
sales tax increase would, at a minimum, result in the loss of 99,000
jobs and leave Ohio's capital stock $8.8 billion smaller. The analysis
shows that there is a 90% probability that this outcome will occur.
Economic Effects of Increasing the Ohio State Sales Tax from 5% to 6%
in Capital Stock
Tax Revenue Effect
Tax Revenue Effect
increase would lower employment by at least 1.7%. As a result, the annual
payroll in Ohio would fall by $2.9 billion. This would raise the state
unemployment rate, which stood at 4.4% in November, to as much as 6%.
It is noteworthy that when Ohio raised the sales tax from 4% to 5% in
1981, the unemployment rate increased from 8.9% in December 1980 (1.6%
above the national average of 7.3%) to 13.7% in December 1982 (4.0%
above the national average).
increase would produce a net revenue gain of up to $1,024 million in
1998. This is the net result of two effects: (1) the static
revenue gain of $1,143 million (computed on the assumption that the
tax hike had no effect on the Ohio economy) and (2) the dynamic
revenue loss of at least $119 million (the revenue lost as a result
of the decreased production and personal income brought about by the
are needed in order to measure the effect of the tax increase on the
variables of interest these variables being the number of jobs
(L), the wage rate (w), the capital stock (K) and state tax revenue
(TR). First we must establish baseline values for the variables, projecting
them out through the end of 1998. Then we use the Beacon Hill Institute's
State Tax Analysis Modeling Program (STAMP) to estimate and project
employment, wages and the capital stock in the presence of a tax increase.
Baseline Projections of Wages, Jobs and Capital
projections are shown in the table below and were constructed as follows.
Information on the number of jobs is available through 1996 and
information on the number of workers is available for 1997. We
assume that the number of jobs in 1997 grows at the same rate as the
number of workers did for the first eight months of 1997 relative to
the first eight months of 1996 (1.13%), and assume that the number of
jobs in 1998 grows at the same speed as it did from 1995-1997 (1.74%).
of the total payroll is known through 1996, and we assume that
it will continue to grow (in nominal dollars) for the rest of 1997 at
the same speed as it did between the first half of 1996 and the first
half of 1997, which is by 5.70% per year. We assume that it grows at
the same speed in 1998 that it did from 1995-1997 (5.27%). We also assume
that the capital stock grows at the same speed as the total payroll,
so that the capital to labor ratio does not change. Since information
on the capital stock in Ohio is available for 1995, we use the historical
growth rates of payroll to generate the capital stock value for 1996,
and the projected growth of payroll to arrive at the capital stock for
1997 and 1998. The average wage is simply the total value of payroll
divided by the number of jobs.
sales tax base for the calendar year 1994 ($92,076 million) was estimated
by taking an average of sales tax collections for fiscal year 1994 and
fiscal year 1995 and dividing them by the sales tax rate of 5%. The
1996 sales tax base ($97,181 million) was derived in a similar manner.
For 1996 ($102,569 million), 1997 ($108,256 million) and 1998 ($114,258
million), we assume that the sales tax base grows by the 1995 growth
Applying the Tax Analysis Model
description of the tax analysis model is given in The Economic Effects
of Changing the Ohio Sales Tax: Estimates Using the BHI State Tax Analysis
Modeling Program (Beacon Hill Institute, January 1998); the basic
model has been modified and re-estimated so that it is applicable to
Ohio.  The model is designed to allow
the analyst to trace the effects of changes in state tax rates on employment,
wages and the capital stock. It begins with a series of structural equations
that aim to capture the behavior of firms and households, and then rearranges
these equations to arrive at a set of reduced form equations which are
both theoretically consistent and may be estimated econometrically.
The equations are estimated using data from 1970-1994. In simplified
form, the two that are relevant here are the labor equation and the
labor equation shows how changes in state sales tax rates (and other
variables) affect the number of jobs in Ohio. The estimated equation
is of the form
= -0.0375t + other terms
ln(L) is the natural log of the number of jobs, and t is the state sales
tax rate. The coefficient -0.0375 is statistically significant, and
measures the effect of a change in the tax rate (t) on ln(L);
in other words ln(L)/t
= -0.0375. With 90% certainty, the coefficient is equal to -0.0375 +
1.645 x 0.01215, or somewhere in the interval between -0.0575 and -0.0175.
Since our concern is with the minimum reasonable effects of the tax
change on labor demand, it is the latter number (i.e. -0.0175) that
we need to use.
equation is similar, except that the dependent variable is capital
rather than labor. Specifically the estimated equation is of the form
= -0.0493t + other terms
ln(K) is the change in the natural log of the value of the capital stock
from one year to the next. The coefficient -0.0493 is statistically
significant, and with 90% probability lies between -0.0735 and -0.0251.
Projecting the Effects of the Tax Increase: Employment
the minimum number of jobs that will be destroyed as a result of the
tax hike. Since t increases from 5% to 6%, we have t = 1.0. Thus
(3) ln(L) = (-0.0175)t = (-0.0175)(1.0)
value of ln(L) [=15.5543 = ln(5,690,274)] now falls by 0.0175 to 15.5368;
taking the antilog gives the number of jobs with the tax hike, which
(when done precisely) is 5,591,736, or a decrease of 98,538 below the
Projecting the Effects of the Tax Increase: Capital
effects of the tax increase on the capital stock are estimated in the
same manner as for employment. Thus
(4) ln(K) = (-0.0251)t = (-0.0251)(1.0)
value of ln(K) [=12.7751 = ln($353,297 million)] now falls by 0.0251
to 12.7500; taking the antilog gives a new capital stock, after the
tax increase, of $344,530 million, or a decrease of $8,767 million over
the baseline case.
Projecting the Effects of the Tax Increase: Wages
reduced form equations of the tax analysis model show that the state
sales tax rate does not have a statistically significant effect on the
wage rate in Ohio. Wages are thus assumed to follow the baseline projections
both with, and without, the tax increase. The total value of the payroll,
in the presence of the tax hike, is calculated by multiplying these
average wage rates by the number of people employed.
Projecting the Effects of the Tax Increase: Tax Revenue
would a hike in the tax rate have on state tax revenue? First there
is a static revenue gain, which is measured as the increase
in the sales tax rate times the sales tax base.
revenue gain would be $1,143 million (=1.0%*$114,258 million). But this
overstates the true revenue gain, because there is also a dynamic
revenue effect: The tax increase leads to an decrease in the number
of jobs and hence the total payroll, and therefore to some offsetting
decrease in revenue. Since the number of jobs falls by (at least) 1.73%,
the dynamic revenue loss is 1.73% x 6% x 114,258 = $119 million.
Effect of Ohio Tax Increase on Employment, Capital Stock and Tax Revenue*
wage ($ p.a.) (=B/A)
stock ($ mill)
sales tax base ($ mill)
sales tax rate
Effects with Tax Increase
sales tax rate
in presence of tax increase
decline with tax increase (=A-H)
stock in presence of a tax increase ($ mill)
in capital due to tax increase ($ mill) (=D-J)
in presence of tax increase ($ mill)
in payroll due to tax increase ($ mill) (=B-L)
tax revenue effect: cumulative ($ mill) (=E*(G-F))
tax revenue effect: cumulative ($ mill) (=G*E*((H/A)-1))
tax revenue effect: cumulative ($ mill) (=N+O)
Figures are rounded.
is a 90% probability that the effect of the tax increase will be larger
than the amounts shown
Regression results for Ohio are available upon request.
Last update: 1/15/98
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