Ten gallon economy sizing up economic growth in texas

Illustrations Figures 2.1 Eff ects of State Hiring Credits on Employment Growth, 2007–2011 16 2.2 Range of Estimated Employment Eff ects of 2.3 Averages of Estimated Eff ects on Grow

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Ten-gallon economy : sizing up economic growth in Texas / edited by Pia M Orrenius, Jesús Cañas, Michael Weiss

pages cm

Includes bibliographical references and index

1 Economic development—Texas 2 Texas—Economic policy 3 Banks and banking—Texas 4 Texas—Commerce 5 Labor market—Texas I Orrenius, Pia M., editor II Cañas, Jesus, editor III Weiss, Michael, 1954– editor

HC107.T4T34 2015

A catalogue record of the book is available from the British Library

Design by Newgen Knowledge Works (P) Ltd., Chennai, India

First edition: September 2015

10 9 8 7 6 5 4 3 2 1

Softcover reprint of the hardcover 1st edition 2015 978-137-53016-5

ISBN 978-1-349-57379-0 ISBN 978-1-137-53017-2 (eBook)

DOI 10.10 7/9781137530172 5

our hope is that analysis of conditions in our region,

as well as reflections on past experiences and future challenges, will inform and

enlighten citizens and lawmakers

1 Tipping Our Hats to the Ten-Gallon Economy 3

Pia M Orrenius, Jes ú s Ca ñ as, and Michael Weiss

Part II Public Policy and Business Climate

2 Increasing Jobs and Income from Work: Th e Role and

Part III Human Capital and Labor Markets

5 Texas’ Education Challenge: A Demographic Dividend or Bust? 61

Marta Tienda

6 Oil Boom Lowers Human Capital Investment in Texas 79

Anil Kumar

7 Employment Growth and Labor Market Polarization in

Melissa LoPalo and Pia M Orrenius

Part IV Industry and Exports

8 Texas Real Estate: From the 1980s’ Oil Bust to the Shale Oil Boom 109

John V Duca, Michael Weiss, and Elizabeth Organ

9 Th e Evolution of Texas Banking 119

Kory Killgo and Kenneth J Robinson

10 Th e Impact of Changing Energy Prices on the Texas Economy 139

Mine K Y ü cel, Michael Plante, Amy Jordan, and Nicole Lake

11 Texas Comparative Advantage and Manufacturing Exports 159

Jes ú s Ca ñ as, Luis Bernardo Torres Ruiz, and Christina English

Part V Border and Economic Development

12 So Close to Mexico: Economic Spillovers along

Roberto Coronado, Marycruz De Le ó n, and Eduardo Saucedo

13 Border Economic Recovery Lags Rest of State 199

Keith R Phillips and Christopher Slijk

14 Las Colonias along the Texas–Mexico Border 213

Jordana Barton, Emily Ryder Perlmeter, Elizabeth Sobel Blum, and

Raquel R M á rquez

Illustrations

Figures

2.1 Eff ects of State Hiring Credits on Employment Growth, 2007–2011 16 2.2 Range of Estimated Employment Eff ects of

2.3 Averages of Estimated Eff ects on Growth Rates of Changes from

Fortieth to Tenth Position in Rankings of Components of

Tax- and Cost-Related Business Climate Indexes, and

2.4 Contributions of Business Climate Index and Control Variables

to Employment Growth (QCEW), 1992–2008 22 2.5a Relationships Between Economic Growth, Change in

Inequality and Rankings on EFI Business Climate Index,

1992–2008: State GDP Growth Versus Change in the 50–10 Gap 23 2.5b Relationships Between Economic Growth, Change in

Inequality and Rankings on EFI Business Climate Index,

1992–2008: State GDP Growth Versus Change in the 90–10 Gap 23 2.6 Earned Income Tax Credit by Income and Number of Children, 2014 24 2.7 Estimated Eff ects of State Earned Income Tax Credit on

Probability that Family Earnings are Above Poverty Line or

3.1 Texas Consistently Grows Faster than the United States 34 3.2 Texas Population Growing at Twice National Rate 35 3.3 Texas Leads Nation in Exports Since 2002 36 3.4 Texas’ State and Local Per Capita Tax Burden Lower than

3.5 Texas’ State and Local Per Capita Outlays Also Below

3.6 No Clear Relationship between Tax Burden and

3.7 No Clear Relationship between Government Expenditures and

4.1 Texas State Margin Tax Revenue 48 4.2 Disparity in Eff ective Tax Rates in a Simplifi ed Economy 52 5.1a US Age–Educational Attainment Pyramid, 1970 63 5.1b US Age–Educational Attainment Pyramid, 2010 63

5.2 Percentages of Full-Time, First-Time Freshmen Receiving

a Bachelor’s Degree Within Six Years of Enrollment at

5.3 Population Ages 25–34 and 55–64 with a Bachelor’s Degree or

Higher: Selected OECD Nations and Texas, 2010 70 5.4 Texas and US Age–Education Profi les, 2010 71 5.5 Texas Age–Education Profi les: Anglos and Hispanics, 2010 72 6.1 Oil Price Boom and Bust from 1970 to 2010 80 6.2 Change in Mean Real Hourly Wages (Texas Versus Rest of

6.3 Diff erence in Share with College Education in 2010

(Boom Cohort minus Pre-Boom Cohort) 87 7.1 Change in Employment by Wage Quartile, 1979–2012 95 7.2 Change in Employment Shares by Wage Quartile, 1979–2012 96 7.3 Job Growth by Wage Quartile and Decade in Texas 97 7.4 Job Growth by Wage Quartile for Large States, 1999–2012 98 7.5 Change in Employment Shares for Full-Year, Full-Time Workers 99 7.6 Change in Employment Shares by Wage Quartile, 1979–2006 100 7.7 Texas Job and Wage Growth by Industry, 1979–2012 102 7.8 United States Minus Texas Job and Wage Growth by Industry,

8.1 Job Growth in Texas Usually Outpaces the United States,

8.2 Texas Employment Trends Up Strongly Aft er 1980s’ Oil Bust 111 8.3 Unemployment Rate in Texas Usually Below National Rate

8.4 Texas Residential Construction Outpaces the United States,

8.5 Banking Institution Failures Concentrated in Texas During

Savings and Loan Crisis, not in Recent Crisis 114 8.6 Low Inventories Consistent with Rising Infl ation-Adjusted

9.1 National Banks in Texas, 1865–1905 120 9.2 Private Banks in Texas, 1877–1905 121 9.3 Assets in Texas National and State Banks, 1905–1929 122 9.4 Liquidation Rate at Texas State Banks, 1907–1929 126 9.5 Special Assessment on Texas State Banks, 1910–1927 126 9.6 Disposition of Insured Deposits at

Failed Texas State Banks, 1910–1927 127 9.7 Annual Return on Average Assets 130 9.8 Nonperforming Loans as a Percentage of Total Loans 130 9.9 Bank Failures as a Share of All Banks 131 9.10 Relative Growth in Banks and Branches at Year-End 133 9.11 Percentage of Banks with a Texas Ratio Greater than 100 Percent 134 10.1 Texas Crude Oil and Natural Gas Production 140 10.2 Texas Employment Follows Changes in Oil Prices 140

10.3 Location of Major Shale Formations by

10.4 Oil Production Picks Up, Reversing Decades-Long Trend 143 10.5 New Technology Changes Distribution of Texas Natural Gas 144 11.1 Texas Exports Growing Faster than the Nation 160 11.2 Texas’ Main Country Competitors in World Markets 164

11.4 Share of World Manufacturing Exports, Selected US States 168 11.5a Petroleum and Coal Products Manufacturing 170 11.5b Computer and Electronics Product Manufacturing 170 11.5c Transportation Equipment Manufacturing 171 11.5d Fabricated Metal Product Manufacturing 171 13.1 Border Metros Except El Paso See Faster Job Growth than Texas 200 13.2 Business-Cycle Indexes Show Varying Degrees of Volatility

13.3 Weak Employment Growth in Chihuahua Accounts for

13.4 Real Government GDP Growth Higher on Border than in State 205 13.5 Federal Government Job Growth Much Faster on Border than

13.6 Home Health Care Employment Share Higher in

Rio Grande Valley, Border than in State 207 13.7 Border Employment Growth Usually at or Above Texas Rate

14.3 Public Assistance Recipiency: Colonias and Counties 219 14.4 Median Household Income by Area, 2011 220 14.5 Educational Attainment by Area, Persons 25 Years and Older 222 14.6 Earnings Gap Remains with Increased Education for

Tables

5.1 Selected Educational Indicators: Texas and United States, 2011–2012 65 5.2 Texas Racial and Ethnic Disparities in College Readiness, 2010 66 5.3 Percentages of 25- to 34-Year-Olds with a BA or Higher:

6.1 Worker Percent Share by Educational Attainment: Oil and

Gas Versus other Industries in the United States 82 6.2 Worker Percent Share by Educational Attainment: Texas Versus

10.2 Long-Run Variance Decomposition of Texas Nonfarm

10.3 Employment Responses to a 10 Percent Increase in Oil Prices 148 10.4 Employment Responses to a 10 Percent Increase in Gas Prices 149 10.5 Employment Responses to a 10 Percent Increase in Oil Production 154 10.6 State GDP Responses to a 10 Percent Increase in Energy Prices 154 11.1 Texas Shares of World Exports 161 11.2 Texas’ Revealed Comparative Advantage 163 11.3a Ratio of Texas’ Revealed Comparative Advantage with

Employment in Mexican Border Cities, 2007–2012 188 12.4 Employment Estimation Results for US Border Cities, 2007–2012 190 12.5 Employment Estimation Results for Texas Border Cities, 2007–2012 191 12.6 Employment Regressions for US Border Cities with

Industry-Varying Coeffi cients, 2007–2012 192 12.7 Employment Regressions for Texas Border Cities with

Industry-Varying Coeffi cients, 2007–2012 193 12.8 Employment Regressions for US and Texas Border Cities

Under Diff erent Specifi cations, 2007–2012 194

13.2 Government Transfer Payments as a Share of Personal Income 206 14.1 Texas Colonias Classifi cation System 216

About the Title

In Texas, a ten-gallon hat refers to a large cowboy hat with a tall crown Linguists believe that the term, rather than referring to ten gallons of liquid, may have originated from the Spanish phrase “tan gal á n,” meaning “very gallant” or “really handsome.” Thus, the hat conveyed those characteristics on its wearer

Preface

The body of research making up this edited volume was assembled in ebration and recognition of the Federal Reserve Bank of Dallas’ centennial year The papers that form the basis of this book’s chapters were first presented

cel-at the Dallas Fed’s regional centennial conference on November 7, 2014, almost

100 years to the day since the creation of the Bank

Forged out of the Federal Reserve Act in 1913 and established the following year, the Dallas Fed and the other 11 Reserve Banks share responsibility for mon-etary policy with the Federal Reserve Board of Governors in Washington, DC This unique central bank structure reflects the federalist values that underlie many American institutions and grounds US monetary policy in the experiences

of regional economies around the nation This volume offers an in-depth nation of the largest part of one of these regions, Texas

The volume’s contributors include the Dallas Fed’s own economists, many of them renowned in their fields of expertise They are joined by some of the nation’s foremost minds in regional economics and public policy (David Neumark), tax policy (Alan Viard), and education (Marta Tienda)

No single industry or public policy explains Texas’ successes, and no one future challenge looms transcendently large While the state’s triumphs may reflect a combination of adept decisions and good fortune, the key throughout its recent economic history has been Texas’ ability and willingness to change Market forces thrive in the state, guiding investment and fueling growth But where the market’s reach ends, nimble policymaking must often intervene to help leverage past achievement into an equally remarkable future

Texas has set a high bar by which success is measured If the past provides any guidance about the future, the state and its burgeoning population are up to the challenge

to successfully carry out this project

The logistics of the compilation of this volume required the assistance of copy editors, research assistants, and administrative assistants We thank Jennifer Afflerbach, Kathy Thacker, and Carol Dirks for their thorough editing of all the manuscripts We thank Sarah Greer, Emily Gutierrez, and Kristin Davis for com-piling tables and figures We thank Michele Brown for helping assemble all the pieces of this volume for submission to the publisher

Pia Orrenius expresses her deep appreciation to her coeditors, Jes ú s Ca ñ as and Michael Weiss, who worked tirelessly to ensure the quality and readability of every manuscript She also thanks Leila Campoli at PalgraveMacmillan, whose enthusiasm and sense of urgency sped this process along, ensuring a timely publication

Pia Orrenius, Jes ú s Ca ñ as, and

Michael Weiss

Introduction

Tipping Our Hats to the

Ten-Gallon Economy

Pia M Orrenius , Jes ú s Ca ñ as , and Michael Weiss

Abstract : Texas has grown twice as fast as the nation for over 25 years This

fan-tastic growth has lifted many boats Living standards have increased along with employment opportunities, attracting record migration to the state Per capita income was just a percentage point shy of the nation’s in 2014, a level previously achieved only at the height of the 1980s oil boom Meanwhile, Texas’ unemploy- ment rate has fallen below the nation’s and remained there for over a decade Home affordability has remained high—the American dream come true for many There are several reasons for this superior growth record, including low taxes, a business- friendly climate, and booming energy sector This chapter introduces the articles in this volume, which applaud these accomplishments and explore their root causes, all the while raising concerns about the tradeoffs inherent in the Texas model and their implications for the state’s future

Introduction

The Texas economy is the envy of the nation, expanding consistently at twice the national rate Since 1990, job growth has averaged 2 percent per year, com-pared with a national pace of 0.9 percent For every 100 jobs that existed in Texas

in 1990, 63 have been added This compares with 10 for New York and 23 for California Notwithstanding the recent slowdown, no other state boasts of such dynamic expansion over such an extended period and on such a large scale Texas is an economic powerhouse—with an annual output of nearly $1.6 trillion, the Texas economy is the largest in the United States behind California Texas produces more goods and services in a year than do most countries; the state’s economy is equivalent to that of Canada, the world’s fifteenth-largest economy 1 Texas’ output grows so fast—4.3 percent annually on average since the Great Recession—that it has added the output equivalent to Portugal’s economy during the period 2009–2014

The expansion has lifted many boats—and added to the flotilla Living standards have risen along with employment opportunities, attracting record

migration to the state Per capita income was just a percentage point shy of the nation’s in 2014, a level previously achieved only at the height of the 1980s oil boom 2 Meanwhile, Texas’ unemployment rate—historically above the national rate—has fallen, dipping below the national rate in 2003 and staying there since then Home affordability has remained high, even after a burst of postrecession house price appreciation Fifty-six percent of families can now afford their own home in Dallas and Houston, compared with 16 percent in Los Angeles and

25 percent in New York 3

While this volume showcases Texas’ standout growth, it seeks to put it into

con-text Many observers first want to know why Texas grows so fast There are a

num-ber of factors, including the state’s small government Texas has no state income tax, and businesses can operate in a comparatively lightly regulated environment The state has a robust energy sector, producing over 38 percent of the nation’s crude oil and 28 percent of its natural gas Another strength is exports Texas has been the nation’s top-ranked exporting state since 2002; it sent $280 billion in goods abroad

in 2014 Texas’ biggest trading partner is Mexico, with whom it shares a dynamic, industrialized binational border economy and large immigration flows

A second question many ask is whether this growth comes at some cost to be paid in the future With relatively low taxes and low spending, is Texas enjoying growth now at the expense of future prosperity? Is the state’s investment suf-ficient in physical and human infrastructure—not only its bridges, roads, and water resources, but also its children’s education? Alarm bells have sounded for some time along these dimensions Texas has the nation’s largest uninsured pop-ulation, an above-average poverty rate, and educational attainment below the

US average 4 Texas is also home to 500,000 people in colonias—unincorporated developments often lacking basic infrastructure—that are found along the border Signs of lagging progress are evident despite the state economy’s prowess

Public Policy, Business Climate, and Taxes

Casual observation may suggest that the low-tax, low-spending Texas model yields faster growth, but what does the evidence say? University of California professor David Neumark reviews the evidence on the ability of public policy to spur local growth in chapter 2 , “Increasing Jobs and Income from Work: The Role and Limitations of Public Policy.” Policies that target job creation and income growth have a mixed record Some policies help, others have no effect, and still others can make things worse In his overview, Neumark demonstrates that a business-friendly tax and regulatory policy typically spurs job growth but may also increase income inequality This would seem consistent with Texas’ experi-ence, although income inequality has been increasing nationally as well, a topic addressed in chapter 7

Neumark also points out that higher minimum wages are not helpful because they curb job growth for the vulnerable groups they are trying to help; they also

do a bad job of targeting the poor Texas has a relatively low minimum wage—equal to the federal rate A more effective policy to boost income of the working

poor, Neumark says, is a state-run earned income tax credit (EITC) that operates

in concert with its federal counterpart More than a dozen states have adopted such a state tax credit, including most of Texas’ neighbors 5 The EITC is, how-ever, an expensive job-creation program The costs of creating jobs via hiring credits targeting the unemployed, a viable alternative, are much lower than cre-ating jobs with the state EITC

Jason Saving, a Dallas Fed senior research economist, applies Neumark’s foundation to the case of Texas in chapter 3 , “Why Texas Grows Faster: The Role of Smaller Government.” After making a case that Texas is indeed a small-governmen t state—it has the eighth-lowest per capita tax burden in the c ountry—Saving also points out that the tax burden is not well distributed By relying heavily on a state sales tax, Texas disproportionately levies low-income residents Moreover, the low overall state tax rate also masks weightier local taxes; in Texas, local governments (not the state) largely fund public schools and hospitals, and property taxes are relatively high in many parts of the state

Next, Saving argues that a small government by itself is only one side of the coin Taking less away from Texans leaves them with more to spend and invest, which boosts growth However, it also matters how the state spends the money it collects Near-term economic growth is more highly correlated with infrastruc-ture and public-safety spending than with education and welfare expenditures That said, education spending is particularly important when seeking to raise incomes in the long run While Texas lags the national average in spending on K–12 education, Saving demonstrates that the state so far has gotten good bang for its buck with above-average student outcomes However, Saving writes that the Texas model may be due for a correction Rapid economic and population growth has increased the urgency of finding new revenue sources to address looming infrastructure, education, and health care needs Even so, state legisla-tors prefer to cut taxes rather than raise them

One new revenue source has been the Texas corporate franchise tax, put in place in its current form in 2006 So far, the tax has generated less revenue than estimated and has provoked criticism among business leaders In chapter 4 , “The Shortcomings of the Texas Margin Tax,” Alan Viard of the American Enterprise Institute describes how this levy taxes firms on their gross receipts without allow-ing a full deduction for business expenses The so-called margin tax is there-fore similar to a turnover tax, long condemned as inefficient because it imposes

u neven tax burdens on labor used at different stages of production and creates artificial incentives for firms to merge Texas lawmakers have revised the tax

in every biennial session since its original enactment but, as Viard points out, the changes may have made the tax even more distortionary It is instructive to

r ealize that only a handful of US states still have gross-receipts taxes In the 2014 election, Nevada voters overwhelmingly rejected implementing a tax closely pat-terned after the Texas margin tax In Europe, these types of taxes were replaced

by value-added taxes decades ago

Viard acknowledges that it is always difficult to forge a fair and efficient tax system Income taxes punish the rewards from labor, a disincentive to work harder and earn more Moreover, the Texas Constitution prohibits imposing

a state income tax Meanwhile, Texas sales and property taxes are already tively high Oil and gas severance tax revenues are a welcome boost to state cof-fers but are not dependable because of oil price volatility

Human Capital and Labor Markets

The bulk of state tax revenue is earmarked for two purposes: education and health care In chapter 5 , “Texas’ Education Challenge: A Demographic Dividend

or Bust?” Professor Marta Tienda of Princeton University forcefully argues that

by making the right choices now, Texas can harness a demographic dividend—

a productivity boost fueled by human capital investment in its large minority youth cohorts This will require closing achievement gaps along racial and ethnic lines and raising college completion rates Tienda shows that Texas is falling behind in college completion even as the share of graduates continues rising Racial and ethnic differentials are troubling because the largest gaps correspond

to the already large and still fast-growing Hispanic population Hispanics make

up 39 percent of the state’s population and 47 percent of people under 30 By

2030, a majority of Texans will be Hispanic

Another interesting though less well-known force mitigating market tives for greater educational attainment is higher oil prices Research on other oil-producing economies has suggested a link between higher oil prices and lower educational attainment among cohorts of young people Dallas Fed senior research economist Anil Kumar tests this hypothesis in chapter 6 , “Oil Boom Lowers Human Capital Investment in Texas,” using Texas’ experience during the 1970s oil boom Relative wages in Texas rose during the oil boom, increasing the opportunity cost of staying in school Comparing Texas-born cohorts who grad-uated from high school during the oil boom with those in the pre-boom period suggests that the expansion negatively affected college enrollment and reduced the share of individuals with college experience by 3 percentage points

Texas’ recent shale oil boom may very well have had similar adverse effects

on college degree attainment; after all, wages in the oil and gas sector far exceed average compensation, and many high-paying, energy-related jobs do not require college degrees But today’s energy industry is not the energy industry of 40 years ago Drilling and production have become highly sophisticated and mechanized, and workers have to be trained in the use of computers, digital instruments, and other advanced technical equipment While bachelor’s degrees may not be required, vocational training and certificate programs are widespread

One positive consequence of the state’s large oil and gas sector has been its contribution to the creation of well-paying, middle-class jobs Past Dallas Fed research has documented Texas’ prowess in job creation across the wage distribution 6 Using Current Population Survey data on individuals’ employ-ment and wages, and measuring changes in employment over time, LoPalo and Orrenius (2014) show that between 2000 and 2013, middle-class jobs in Texas

grew 42 percent By comparison, the United States sans Texas created no net

new middle-class jobs over that period

In chapter 7 , “Employment Growth and Labor Market Polarization in the United States and Texas,” Melissa LoPalo and Pia Orrenius build on their earlier work in two ways They use census data to study the nature of job growth by decade as far back as the 1980s Then they measure the relative change in the dis-tribution of employment; that is whether middle-class jobs are shrinking in Texas relative to high- and low-wage jobs The results clearly show that despite its massive advantage in job creation, Texas has not been immune to the trend of labor market polarization that has characterized US labor markets over the past three decades Low-paid positions and, to a much smaller extent, high-paid positions, make up a larger share of Texas employment than they did three decades ago

These trends have resulted in a large and growing stock of relatively low-paid, low-skilled workers in Texas The state’s metropolitan areas boast costs of living below the national average, easing the burden of low pay in Texas However, Texas also has a limited social safety net compared with other large states Continued outsized growth in the low-paid workforce suggests that the state may need to consider greater investments in public goods such as education and infrastruc-ture to help level the playing field for future generations

Real Estate, Banking, Energy, and Exports

In chapter 8 , “Texas Real Estate: From the 1980s’ Oil Bust to the Shale Oil Boom,” John Duca and Michael Weiss of the Dallas Fed and coauthor Elizabeth Organ look back to see whether Texas learns from past mistakes The 1980s Texas oil boom and subsequent investment excesses led to the collapse of the state’s banks under the weight of a residential and commercial real estate overhang The chances for a repeat of that calamity in an era of shale energy are small, the authors write, citing the economic diversification and regulatory reform that ensued after the 1980s energy bust Financial institutions are no longer as geo-graphically constrained as they were in the 1980s, and nonbank investors play a larger role in the real estate market

The impact of lessons learned appeared in the years of the Great Recession, when the United States struggled with a wave of mortgage defaults that rippled through the banking system Texas largely avoided the chaos seen elsewhere in the country Amid a changed national regulatory environment, Texas also acted to improve lender resiliency While a 1997 state constitutional amendment allowed homeowners to borrow more against the value of their homes, such lending was limited to 80 percent of the value of a home (including the first mortgage) Even before the 1980s bust, Texas banking boasted a colorful legacy that says much about the independent nature of the state’s financial leaders and their phi-losophy, Kory Killgo and Kenneth J Robinson write in chapter 9 , “The Evolution

of Texas Banking.” After joining the United States in 1845, Texas ally prohibited state-chartered banks, but nationally chartered institutions and private banks could operate unregulated and unsupervised Those private banks along with nationally chartered institutions predominated at the beginning of the twentieth century A constitutional amendment in late 1904 repealing the

constitution-prohibition of state-chartered banking set off a boom in state charters—600 state banks by 1910 One reason was that state banks provided more lending flexibility than national banks At the same time, the law limited bank operations generally

to the area in which banks were chartered That framework largely endured until the 1980s collapse, an event that precipitated wide-ranging changes to the state’s financial landscape, including the fire sale of insolvent Texas institutions to out-of-state banks that were later allowed to operate across state lines

Killgo and Robinson state that the changed Texas banking landscape and ulatory safeguards helped the state avoid the brunt of the subsequent financial collapse From 2008 to 2013, 428 banks failed nationwide They represented almost

reg-6 percent of the commercial banks operating at the end of 2007 By comparison, only nine Texas banks failed in the same period, or about 1.5 percent of the 2007 count Killgo and Robinson credit a state economy that did not face the same challenges experienced elsewhere, in part due to the absence of a Texas residen-tial real estate bubble that prudent policies may have helped avoid

The Texas economy’s resilience in the wake of the Great Recession has been tied to development of new shale oil and gas fields across the state, explain Mine Y ü cel, Michael Plante, and Amy Jordan of the Dallas Fed and coauthor Nicole Lake in chapter 10 , “The Impact of Changing Energy Prices on the Texas Economy.” Shale oil and gas have helped increase state crude oil production from 1.2 million barrels per day in 2010 to more than 3 million barrels per day by late

2014 It is the latest development in a tale that began with the discovery of oil at Spindletop, the gusher that in 1901 propelled Texas into the petroleum age The authors demonstrate that energy has since played an important role in the Texas economy, although its influence has varied over the years

Texas’ dependence on the energy sector in the 1970s and early 1980s—oil was 19 percent of output and 4.7 percent of total employment near the boom’s peak in 1981—began to diminish by the 1990s By 2013, however, the sector had rebounded, accounting for 13.2 percent of Texas output and 2.5 percent

of employment The catalyst for change a decade ago was the shale revolution Horizontal drilling and hydraulic fracturing led to an energy resurgence in areas stretching from the Barnett Shale in North Central Texas to the Eagle Ford Shale

in South Texas Even old oil fields in the Permian Basin got new life

The authors note that the impact of oil price shocks on the state’s economy, especially employment, after 1987 reflects the new technology as well as eco-nomic diversification away from the energy sector Looking at the 1974 to 2014 period, which includes boom and bust cycles for both the Texas economy and the oil industry, the authors use a vector autoregressive model and find that a

10 percent increase in oil prices leads to a 1.3 percent increase in total Texas employment The effects are strongest from 1974 to 1987 and weaker thereafter The authors also show detailed effects by state geographic region

Another booming sector in recent years has been Texas exports In chapter 11 ,

“Texas Comparative Advantage and Manufacturing Exports,” Dallas Fed ness economist Jes ú s Ca ñ as and coauthors Luis Torres and Christina English note that, while Texas has gained global market share in some industries, it has lost ground in others Using detailed trade data, the authors identify the comparative

busi-advantage of Texas’ exports and analyze how that edge has evolved over the past decade The study makes an important contribution because it identifies not only countries that compete with Texas in global markets, but also the top US states that vie with Texas for global market share

The authors find that Texas’ comparative advantage in energy-related tries has improved, consistent with the shale oil and gas boom that that dom-inated state economic growth from 2008 to 2014 Texas also gained domestic competitiveness in the automotive industry against states with a history of domi-nance in that sector, such as Ohio and Illinois, which is also consistent with Texas manufacturing linkages across the Rio Grande to Mexico, where automotive manufacturing is highly concentrated

While Texas has lost market share in computer and electronic products to both domestic and international entities, its comparative advantage in manu-facturing markets has increased as the sector has become more productive over the past decade Additionally, the results show that relative wage differentials have allowed Texas to become more competitive and gain global market share vis- à -vis its closest domestic competitors, which face higher labor costs

Border Economy and Colonias

Manufacturing across the Rio Grande has been a major economic engine and force for economic integration along the US–Mexico border In chapter 12 , “So Close to Mexico: Economic Spillovers along the Texas–Mexico Border,” Roberto Coronado and Marycruz De Le ó n of the Dallas Fed, along with coauthor Eduardo Saucedo, confirm that maquiladoras have become not only an increasingly sig-nificant component of the Mexican economy, but also an important part of US corporate strategy to produce competitively priced goods and services in a global marketplace In addition, as manufacturing in Mexican cities has grown, the demand for services provided on the US side has also expanded In this chapter, the authors ask how the growth of maquiladora activity in Mexican border cities affects employment on the US side

Estimating the impact of maquiladora activity on US border cities from 2007

to 2012, the authors find that a 10 percent increase in maquiladora activity in a Mexican border city leads to a 1.1 to 1.5 percent increase in employment in the neighboring US border city The results are heterogeneous along the US–Mexico border For instance, the authors find that the benefit Texas border cities realize from maquiladora activity in northern Mexico is larger than for border cities in the other states

In chapter 13 , “Border Economic Recovery Lags Rest of State,” Keith Phillips and Christopher Slijk of the Dallas Fed’s San Antonio Branch demonstrate that during the recent postrecession period, economic growth on the Texas border with Mexico has been below that of the rest of the state Headwinds to border growth

in the years to come include curtailed government spending, on health care in particular, and reduced retail trade, or cross-border shopping, due to crime and insecurity in northern Mexico The US border single-family home market will also

remain under pressure without changes to lending standards to allow low-income families, prevalent along the border, greater access to credit Nevertheless, a young, growing labor force and the continued integration of the US and Mexican econo-mies will give the border economy ample room to expand as conditions improve in the United States and Mexico, according to Phillips and Slijk

Away from the larger Texas border communities that serve as commercial centers sit scattered, unincorporated subdivisions often lacking basic services such as water and sewer, paved roads and electricity Typically areas of grinding poverty, these “colonias” exist because they offer residents an opportunity to own

a home and build equity, albeit on a pay-as-you-go basis in which legal and cial guarantees are few, note Jordana Barton, Elizabeth Sobel Blum, and Emily Ryder Perlmeter of the Dallas Fed and coauthor Raquel Marquez in chapter 14 ,

finan-“Las Colonias along the Texas–Mexico Border.”

A half-million people live in the 2,294 colonias in Texas, which began ing about a half-century ago as landowners, mostly along the state’s border with Mexico, cut their holdings into individual lots and began selling the parcels, even though there were no services available The Legislature intervened in

appear-1989, requiring platting and infrastructure in new subdivisions and ting funds to meet existing colonias’ water and sewer needs—essentially acting

commit-to prevent development of new communities

Improving life in the colonias will require that four conditions be met, the authors suggest Residents must be active participants in efforts to improve their communities; approaches must be integrated rather than individually targeted (e.g., addressing poverty or housing as separate issues); individual and commu-nity assets must be employed, including Spanish proficiency and entrepreneurial skills; and residents must control the resources that will allow them to operate in the formal economy

Conclusion

In 2006, Texas became the leading destination for interstate migrants, and it has netted over 1.5 million arrivals since A quarter of domestic transplants come from California, which is the largest sending state by far, with the rest coming mostly from other large states and Texas’ neighbors

Rapid economic growth for most of the past four decades has been the key tor attracting people to Texas, while the friendly business climate has attracted employers But what has generated the opportunities that new Texans seek? The energy sector has boomed recently, attracting people and capital But for much of the state’s recent economic history, oil prices have either been low or falling, and the state survived by diversifying away from energy production into high-tech, finance and insurance, professional and business services, nonenergy manu-facturing, medicine, defense, and other industries Diversification of the Texas economy in the 1990s following the 1986 oil bust provided a powerful jobs mag-net, creating economic opportunities for millions The state’s relatively low cost

fac-of living, low taxes, and minimal regulatory burden in concert with abundant land provided a welcoming environment for people and businesses alike

But with people comes challenges, as many of this volume’s contributors point out Since 1990, the Texas population has grown 58 percent, adding 9.9 million people The population is nearly double what it was in 1980 Within Texas today, the foreign born make up over one-sixth of the population and minorities make

up over half Income inequality is on the rise, and educational attainment among Texans lags behind the nation, particularly among the outsized young minority cohorts While schooling outcomes are improving, it may not be happening fast enough When the oil and gas sector is booming, there is less need for a college degree, but after the boom comes the inevitable bust, or so goes Texas history thus far And labor market polarization—the shrinking of the middle class—is happening in Texas despite rapid job growth across the wage distribution

In the face of these challenges, the key to Texas’ continued success lies not in one industry or a single public policy but in the broader realization that there must be change Texas perseveres because it changes when it has to Whether it is

in the wake of a massive oil collapse, as in the 1980s, or the high tech bust in 2001

or the Great Recession, the state’s markets and institutions adapt Texas has long benefitted from flexible prices, wages, and regulations that allow deployment of the factors of production to their most efficient use In its commitment to pro-viding Texans with economic opportunity, the state’s remaining institutions will also have to respond

on housing

4 See Steve H Murdock, Michael E Cline, Mary Zey, P Wilner Jeanty, and Deborah

Perez, Changing Texas: Implications of Addressing or Ignoring the Texas Challenge

(College Station: Texas A&M University Press, 2013) The authors provide detailed demographic projections of education attainment by race and ethnic groups in Texas

5 New Mexico, Oklahoma, and Louisiana all have state earned income tax credit programs

6 See Melissa LoPalo and Pia M Orrenius, “Texas Leads Nation in Creation of Jobs at

All Pay Levels,” Federal Reserve Bank of Dallas, Southwest Economy , First Quarter

2014

Public Policy and Business

Climate

Increasing Jobs and Income from Work: The Role and

Limitations of Public Policy

David Neumark

Abstract : I provide an overview of research findings spanning many dimensions

of policies intended to increase jobs or increase income from work Among job creation policies, there is some evidence that well-designed hiring credits or steep wage subsidies can increase the number of jobs, and business-friendly tax poli- cies may spur job growth although also increasing income inequality Evidence

on enterprise zones generally does not establish job creation effects The earned income tax credit successfully raises income from work, whereas a higher mini- mum wage entails some job loss and does not do a good job at delivering benefits

to poor families

Introduction

The slow recovery of the labor market from the Great Recession has generated

i nterest in explicit policies to encourage job creation and higher income from work, above and beyond general countercyclical monetary and fiscal policy

I provide an overview of my research findings spanning many dimensions of

p olicies intended to increase jobs or increase income from work I first discuss job creation policies, including hiring credits, enterprise zones, and the busi-ness climate generally I then turn to policies to increase income from work—specifically minimum wages and the Earned Income Tax Credit

Subsidizing Job Creation

Hiring Credits

In response to the Great Recession, state and federal policymakers adopted ing” tax credits to encourage employers to create jobs The tax credits subsidize wages for eligible workers and businesses, which should boost employment by

“hir-reducing the cost of labor However, hiring credits are simpler in theory than in practice If they do not reward net new job creation, they end up paying for hiring that would have occurred anyway, generating windfalls for employers, or creat-ing incentives for employers to churn their workforce, hiring some workers and firing others And when hiring credits target narrow, disadvantaged groups, they can stigmatize such workers by signaling low productivity to employers

To study whether the credits adopted during and after the Great Recession helped create jobs, Neumark and Grijalva (2013) constructed a detailed database

of state hiring tax credits, which includes 30 enacted during and after the Great Recession These credits differ along many dimensions Here I focus on two: Credits targeting the unemployed, which in a period of high unemployment

recapture of credits if net job creation is lower than required

We used data on monthly employment growth from the Quarterly Census of Employment and Wages (QCEW) and quarterly data on employment growth and hiring from the Quarterly Workforce Indicators (QWI) We isolate the effects of state hiring credits by examining job growth and hiring in states that imple-mented these credits, compared with states that did not, controlling in a statistical model for other factors that affect employment and hiring, such as unemploy-ment insurance benefits, minimum wage, and federal stimulus spending Preliminary evidence in figure 2.1 shows the effects of these two types of state hiring credits on monthly employment, allowing the effects to evolve over a year

Change in employment (percent)

Figure 2.1 Effects of State Hiring Credits on Employment Growth, 2007–2011

Notes : The heights of the bars measure the cumulative effects through the indicated periods The solid boxes

indicate estimates that are statistically significant at the 5 percent or 10 percent level Estimates are based on a state database of state hiring credits and the Quarterly Census of Employment and Wages

For example, credits targeting the unemployed boosted employment by 0.84 percent after 12 months It is highly unlikely that states spent anything close to 0.84 percent

of payrolls on these credits, suggesting that the benefits outweighed the costs The evidence on hiring in the QWI data also indicates that credits targeting the unemployed and allowing recapture increased employment However, the positive estimates for hiring are about ten times as large as those for employment growth, suggesting that these credits may generate considerable job churning The churning evidence for recapture provisions suggests that despite incentiv-izing net job creation, these provisions may not prevent businesses from claiming credits for some hiring that does not on net create new jobs, although they can still be cost effective (Neumark 2013)

Finally, recent evidence on different ways of subsidizing hiring during and after the Great Recession also points to positive conclusions The American Recovery and Reinvestment Act (ARRA) included a $5 billion fund (the TANF Emergency Fund) under which states could receive 80 percent reimbursement for spending on subsidized jobs States were not limited to subsidizing jobs for families receiving TANF (Temporary Assistance for Needy Families), and many chose a broader target population and sometimes paid 100 percent of wages for a short period (Lower-Basch 2011)

The program resulted in a large number of job placements—approximately 260,000 placements during 2009 and 2010 (Warland, Young, and Lower-Basch, n.d.) Even with a 100 percent subsidy, there are potential savings to t axpayers—more so if the jobs last beyond the subsidy Suggestive evidence from the Texas Back to Work program finds high continuation rates of employment (63 p ercent) after subsidies ended and net savings from reduced unemployment insurance (Warland, Young, and Lower-Basch, n.d.) Other evidence from Florida finds increases in earnings and employment in the four quarters after the program ended (Roder and Elliott 2013), with similar effects for the long-term unemployed

To summarize, specific types of hiring credits that states adopted during and after the Great Recession—in particular, credits targeting the unemployed, those with recapture provisions, and those with deep wage subsidies—appear to have succeeded in boosting employment, in some cases with effects that persisted beyond the subsidy period But many other types of hiring credits studied by Neumark and Grijalva (2013) failed to do so

Enterprise Zones

Federal or state enterprise zones are a different policy that often involves ing tax credits and other incentives Enterprise zones are a “place-based” policy, targeting incentives based on the location of businesses or workers For example, federal Empowerment Zones consist of relatively poor, high-unemployment cen-sus tracts, and offer businesses tax credits for hiring zone residents (initially up

hir-to $3,000 per worker), as well as providing block grants for purposes such as ness assistance, infrastructure investment, and training programs Many state enterprise zones also offer hiring credits

Because workers and businesses may move to different locations as a result of these kinds of incentives, the effects of place-based policies can be very complicated Moreover, these mobility responses to place-based policies can undermine their effectiveness, resulting in benefits going to those who were not the intended benefi-ciaries, or increasing economic activity in one area but reducing it in another One key rationale for enterprise zones is distributional—to create jobs in poor areas Reflecting this, eligibility for enterprise zones is often based on the low socioeconomic status of residents For example, in Texas, a census block is eligible for state enterprise zone benefits if its poverty rate exceeds 20 percent Policymakers might be willing to trade lower economic activity in other areas

to create jobs in poor areas Even so, mobility responses can undermine the distributional intentions of enterprise zones For example, as the subsidy raises wages and employment, other workers may move in, resulting in higher house prices and rents that generate gains for property owners Moreover, some of the job market gains accrue to those who moved in, and original residents may be pushed out by higher rents or simply find it more expensive to live in the area

As a result, assessing the evidence on enterprise zones requires looking at many margins along which behavior can adjust

Turning first to job creation, while mixed overall, most of the evidence on employment effects does not support the conclusion that enterprise zones create jobs 1 Figure 2.2 displays ranges of preferred estimates from eight recent studies Many of the studies find no evidence of employment effects, although three pro-vide evidence of large positive effects

Florida:

Elvery (2009)

Texas:

Freedman (2013)

Federal:

Hanson (2009)

Various states: Ham

et al (2011)

Federal: Busso

et al (2013)

Federal: Ham

et al (2011)

Change in employment (percent)

Lower bound Upper bound

Figure 2.2 Range of Estimated Employment Effects of Enterprise Zone Programs

Notes : In most cases, the different estimates come from alternative statistical approaches; but for the Ham et al

(2011) state estimates, the range is over estimates from different states

The Ham et al (2011) estimates likely do not reflect the true effects of prise zones, as this study’s estimates suggest that some of the largest employment effects occur in states with no or trivial hiring credits, and some of the smallest effects were in California, which had a large hiring credit Its federal estimates ranging from 10 to 34 percent suggest implausibly large effects, especially at the upper end The Busso et al (2013) estimates are large but somewhat more moder-ate They could reflect a unique feature of early federal Empowerment Zones—specifically the large block grants—although there is no direct evidence on this Finally, Hanson (2009) also examines federal Empowerment Zones and finds little evidence of an employment effect

Even if enterprise zones create jobs, assessments of their effectiveness are pered by other findings First, federal Empowerment Zones do not appear to have reduced poverty or helped other low-income families (Hanson 2009; Reynolds and Rohlin 2015) Second, there is consistent evidence of housing price increases (including evidence in Texas from Freedman 2013) Additional results point to negative spillover effects on nearby areas, indicating that enterprise zones largely rearrange the location of jobs among fairly comparable areas rather than creating more jobs, suggesting at best modest redistribution of jobs to poorer areas Why would enterprise zones fail to create jobs when other hiring credits do so? One possibility is that enterprise zone hiring credits can sometimes be claimed many years after the hiring occurred As a consequence, there is often an army

tem-of tax consultants helping companies claim credits for past hiring—making it less likely that these credits incentivize new job creation Second, enterprise zone hiring credits typically have not stipulated requirements for job creation or recapture provisions Thus, it is possible that incorporating better designed hiring credits could enhance the effects of enterprise zones

State Business Climate and Job Creation

State “business climate” is often invoked as an important determinant of job growth, fueled by a cottage industry that produces state business climate indexes These business climate indexes are prominent in policy debate; for example, they are often invoked in arguing for lowering taxes and regulations in states that do poorly on indexes emphasizing these policies However, such arguments can be made selectively, because different state business climate rankings focus on alter-native dimensions of state policy

What does the evidence say about the business climate and these indexes?

Do they in fact predict job growth? And does this depend on which policies the indexes emphasize?

Our research on this question looks at well-known state business climate indexes that are amenable to research because they make their methods trans-parent and provide the underlying data 2 These indexes emphasize different sets of policies, and hence differ significantly in how they rank states Of the ten indexes considered, five are “productivity/quality-of-life” indexes that stress factors related to productivity—such as human capital, infrastructure, and business incubation—and quality-of-life—such as crime and health insurance

The other five are “tax-and-cost” indexes and emphasize tax burdens, nontax costs of doing business, size of government, regulation, litigation, welfare spend-ing, and other transfer payments Given these differences, states are rated dif-ferently by the two types of indexes, leading to notable differences in rankings For example, California is ranked in about fifteenth place on the productivity/quality-of-life indexes but forty-sixth on the tax-and-cost indexes (a low number corresponds to a better ranking, like in college football), while for Texas the order

is reversed, at twenty-fifth and thirteenth place, respectively

We studied the relationship between these indexes and growth using ment data from the QCEW and state gross domestic product (GDP) data, using statistical models that take into account other factors that can influence growth, including weather, proximity to the coast or water, population density, and base-line state industry mix that can affect state economic growth simply because of national industry trends We have to interpret the results cautiously, because the indexes summarize a large basket of policies, and there is not one right way to weight them

One key finding is that the economies of states ranked high on the cost indexes (meaning low taxes and costs) tended to grow faster For example,

tax-and-a sttax-and-ate moving from fortieth to tenth pltax-and-ace on these indexes would htax-and-ave ftax-and-aster employment growth by 0.21 to 0.37 percentage point per year, which is large rela-tive to a mean growth rate of 1.61 percent The estimated magnitudes are similar for state GDP, although the statistical evidence is weaker In contrast, there is

no systematic relationship between the productivity/quality-of-life indexes and growth The analysis also identifies two subsets of policies as particularly impor-tant for growth, based on subindexes of the overall indexes: corporate tax sim-plicity and uniformity with federal taxation boost state GDP growth; and higher welfare and transfer payments slow employment growth

Nonetheless, the role of the basket of policies captured by these indexes should not be overstated Figure 2.3 shows the estimated effects on job and economic growth of similar changes in the ranking on these tax-and-cost indexes and in the ranking on nonpolicy factors The figure indicates that the baseline industry composition and mild weather are relatively more important Figure 2.4 provides more detail, plotting the contributions of business climate and the combined nonpolicy factors for each state The graph is much taller than it is wide, indicat-ing that the nonpolicy factors (controls) explain more variation We can also see where particular states stand

For example, in Texas the contribution of the business climate as captured

by tax-and-cost indexes is very favorable, and the contribution of nonpolicy factors is quite favorable A contrast is frequently drawn with the business cli-mate in California The graph shows that California’s business climate as cap-tured by these indexes is considerably worse But the contribution of the other factors is a bit more favorable, reminding us that in states such as California, other favorable features can offset a poor business climate (i.e., high taxes and costs) Of course, states can to some extent control the policies captured in the business climate indexes, while the other factors are largely outside of their control

However, growth is not the only criterion for evaluating a state’s economic performance Some policies—such as higher welfare and transfer payments—might slow growth but promote other goals, such as equity Nonetheless, eco-nomic growth cannot be ignored, since it is the long-run source of the resources that society can use to pursue its other goals

In a period of rising earnings inequality, policymakers may be especially ing to forgo some growth to increase income equality What does the evidence say about the business climate, as captured by these indexes, and inequality? Using similar models, but supplemented by estimates of poverty and income inequality,

will-we found that the productivity-related indexes that failed to predict economic growth also failed to predict changes in the income distribution However, the same tax-and-cost indexes that predict faster economic growth predict increases

in income inequality, pointing to an equity-efficiency tradeoff with respect to state-level public policy, growth, and income inequality

Population density Mildness

Business climate

index

Industry composition effect

Population density Mildness

Figure 2.3 Averages of Estimated Effects on Growth Rates of Changes from Fortieth to

Tenth Position in Rankings of Components of Tax- and Cost-Related Business Climate Indexes, and Comparisons to Nonpolicy Factors

Notes : The data are from the business climate indexes, the Quarterly Census of Employment and Wages (QCEW)

(employment), the Bureau of Economic Analysis (state GDP), and other sources Estimates are averaged over multiple business climate indexes

Source : Kolko, Neumark, and Cuellar Mejia (2013)

Figures 2.5a and 2.5b summarize the evidence Each figure plots a regression line relating state GDP growth to the change in inequality (for the differences between the fiftieth and tenth percentiles of the family income distribution, and between the ninetieth and tenth percentiles) The horizontal axis is measured

as the negative of the increase in inequality, so that a negative slope implies that where state GDP growth was higher, inequality increased by more The slope is negative for each inequality measure, documenting that inequality increased more where growth was higher

To show the relationships between these outcomes and policy, the graphs also plot each state’s value of these two outcomes, as well as its ranking on the Economic Freedom Index (EFI) averaged over the years for which it is available The corner of each quadrant—defined in terms of medians—lists the state’s mean rank and the number of observations The mean ranking of states in the upper-left quadrant is always the highest and the mean ranking of states in the lower-right quadrant is either the lowest or nearly the lowest, implying that states that rank high on this tax-and-cost index have higher growth but larger increases

South Northeast Midwest West

GA ID

IL IN IA KS

NE NV

NH NJ

SC SD

TN

TX UT

WA WV

Contribution of control variables

Contribution of business climate

Figure 2.4 Contributions of Business Climate Index and Control Variables to Employment Growth (QCEW), 1992–2008

Notes : Graph shows estimated effects of business climate index and control variables relative to mean Units are

percentage points of annual employent growth The data are from the business climate indexes, the Quarterly Census of Employment and Wages (QCEW), the Bureau of Economic Analysis (state GDP), and other resources Estimates are averaged over multiple business climate indexes

Source : Kolko, Neumark, and Cuellar Meija (2013)

36 13 46

40

15 37 20

47

4

33

12 7

Notes : The horizontal axis is the negative of the increase in inequality The plotting symbols are rankings in the

indexes, with 1 being the highest ranked (lowest taxes) Results are shown for the Economic Freedom Index (EFI), which provided the strongest and most consistent evidence The data are from the business climate indexes, the Quarterly Census of Employment and Wages (employment), the Bureau of Economic Analysis (state GDP), and other sources

Source : Neumark and Muz (forthcoming)

17

36 13 46

40

15 37

20 38

35

14 45 37

19

6

6

47 4

33 12

31 40

Avg annualized 2-year % State GDP growth

Labeled by average EFI ranking

Figure 2.5b Relationships Between Economic Growth, Change in Inequality and Rankings on EFI Business Climate Index, 1992–2008: State GDP Growth Versus Change

in the 90–10 Gap

Notes : The horizontal axis is the negative of the increase in inequality The plotting symbols are rankings in the indexes,

with 1 being the highest ranked (lowest taxes) Results are shown for the Economic Freedom Index (EFI), which vided the strongest and most consistent evidence The data are from the business climate indexes, the Quarterly Census of Employment and Wages (employment), the Bureau of Economic Analysis (state GDP), and other sources

pro-in pro-inequality, while states that rank low have lower growth but more moderate increases in inequality

Thus, the same policies in the tax-and-cost indexes tend to be associated with

faster economic growth and larger increases in inequality This suggests that

p olicymakers—and society at large—have to make tradeoffs when choosing policies affecting taxes and the costs of doing business; the policies that enhance growth may also increase inequality This conclusion is reinforced by evidence from business climate subindexes that the tax-and-cost-related policies that are most strongly related to both rising inequality and faster growth are less-generous welfare and transfer programs

Increasing Income from Work

The Earned Income Tax Credit (EITC)

The EITC supplements earnings for low-income families and has grown into the major US program (around $60 billion annually) to boost earnings of working people Figure 2.6 shows key features of the EITC

First, it provides supplemental income only to those who are working Second,

it provides a growing subsidy on the upward-sloping part of the schedule (the

“phase-in” range), and then at higher income a higher implicit tax rate as the subsidy is phased out Third, the subsidy value varies sharply with the number of

Figure 2.6 Earned Income Tax Credit by Income and Number of Children, 2014

Note : The number of children refers to the number of eligible children in the tax unit

Source : Tax Policy Center, http://www.taxpolicycenter.org/taxfacts/displayafact.cfm?DocID=36&Topic2id=40&

eligible children The subsidy and maximum payment is trivial for those without children, but both are much higher for those with children For example, for a family with two children, in 2014 the maximum credit that could be earned was

$5,460; over the first $13,650 in earnings, this represents a 40 percent subsidy to earnings Finally, note that the EITC is based on family income, and in particular low family income, and hence will tend to go to single-parent families, where incomes are much lower on average

Given this structure, the EITC targets low-income families well, with a large proportion of EITC payments going to poor and low-income families (Liebman 1998) Moreover, the EITC is a pro-work policy, boosting employment and earn-ings particularly among single mothers (Hotz and Scholz 2003)

In the 2000s, many states started to supplement the federal EITC with their own EITCs, which is a boon to researchers estimating effects of different poli-cies Neumark and Wascher (2011) estimated the effects of the multitude of state expansions in the EITC in the 2000s, when over a dozen states added EITCs We focus on families with heads aged 21 to 44—ages when families are most likely to have children eligible for the EITC—and estimate effects on the probability that a family’s earnings are above the poverty line, or above one-half of the poverty line (extreme poverty) The focus on earnings poses a rather strict test of the power of the EITC to increase income from work, by excluding the work-contingent trans-fers of the EITC (which are also excluded from official US poverty calculations) The results are reported in figure 2.7 The generosity of the EITC is measured

by the percentage state supplement to the federal EITC, and its impact is mated from the relative effect on families with children

Figure 2.7 Estimated Effects of State Earned Income Tax Credit on Probability that

Family Earnings are Above Poverty Line or One-Half of Poverty Line

Notes : The solid bars indicate estimates that are statistically significant at the 5 percent or 10 percent level

Data come from the Current Population Survey Annual Demographic Files and other sources