Research Highlights

Research on job effects of taxing and spending can tip states’ budget math

Recent high-quality research suggests that a state government’s “fiscal policies”—its taxes and spending—can have much larger short-run effects on a state’s economy than previously thought. In the short run, a government can significantly increase private-sector jobs in a state by increasing public spending or reducing taxes on households in the bottom 90 percent of the income distribution and paying for it with increased taxes on households in the top 10 percent of the income distribution.

Unlike the federal government, state governments must annually balance their budgets. Increased taxes take money away from state taxpayers and thus reduce demand for goods and services in the state economy. Increased public spending pumps more money into the state economy and increases demand for goods and services. Do these effects offset, when a state undertakes a “balanced budget” increase in both taxes and spending? The traditional conventional wisdom has been: “Mostly.” Any net effect of increasing both taxes and spending on demand for goods and services in a state, and hence on private sector jobs, has been thought to be modest.

An Upjohn Institute working paper from senior economist Timothy J. Bartik analyzes recent research and concludes that secondary effects, or multipliers, can dramatically alter states’ budget math. The short-run job creation effects of state balanced-budget policy changes can be considerable.

The new research shows it takes far less public spending to create a job than previously thought. The most relevant recent paper implies that typical state public spending will create jobs in a state at an annual cost of only $34,000 per job created.

Other new research suggests that tax cuts for households in the bottom 90 percent of a state’s income distribution have more powerful short-run job creation potential per dollar than previously thought. This recent research implies that tax cuts for the bottom 90 percent create one job for only $39,000 in cuts. In contrast, this recent research finds no short-run effects on a state’s jobs of tax cuts or tax increases for households in the top 10 percent of a state’s income distribution.

How does this matter for state policymakers? First, it adds an argument for increased public spending, if financed by tax increases on the top 10 percent. As shown in previous research by Bartik, the social benefits of a new jobs are likely to be somewhat less than $34,000 per job, so such a balanced budget policy would not be justified by job creation benefits alone. But for proposed public spending programs that have some significant benefits on their own, these additional job creation benefits may be sufficient to help tip a benefit-cost test, making benefits exceed costs where they hadn’t under previous calculations.

Second, this new research evidence adds another reason for modestly increasing the progressivity of state tax policies, beyond considerations of fairness. In the short run, in the average state, cutting taxes on the bottom 90 percent, and increasing them on the top 10 percent, is likely to increase demand for goods and services in the state economy, and thus to increase private sector job creation. Bartik cautions that this new research should not be extrapolated beyond the range of tax policies actually observed in different states.

Third, this new research suggests that the job-creation effect of business tax incentives, such as property tax abatements or job creation tax credits, might be significantly reduced, depending upon how business tax incentives are financed. Using this new research, Bartik estimates that if a business tax incentives policy is financed either by spending cuts or tax increases on the bottom 90 percent, such financing might offset one-third or more of the potential job-creation benefits of business tax incentives.

Fourth, this new research strengthens the argument that, in the short-run, states with budget deficits are likely to do much less damage to state private sector job creation by increasing taxes on the top 10 percent of the income distribution than by cutting public spending or increasing taxes on the bottom 90 percent.

Download "New Evidence on State Fiscal Multipliers: Implications for State Policies" by Timothy J. Bartik.