Do Property–Casualty Insurance Firms Locate to Minimize Insurance Premium Taxes?

• Author: David L. Sjoquist,Martin F. Grace
• DOI: http://doi.org/10.1111/rmir.12103
• Published date: 01 March 2019
• Date: 01 March 2019

Risk Management and Insurance Review

C

Risk Management and Insurance Review, 2019, Vol.22, No. 1, 101-125

DOI: 10.1111/rmir.12103

FEATURE ARTICLE

DOPROPERTY–CASUALTY INSURANCE FIRMS LOCATE

TO MINIMIZE INSURANCE PREMIUM TAXES?

Martin F. Grace

David L. Sjoquist

ABSTRACT

States levy insurance premium taxes, which are essentially gross receipt taxes

on premiums, with insurance companies paying the higher of the tax rate in

the state in which the company is domiciled and the state in which the policy is

written. Using firm-level data for the property–casualty (P-C) insurance indus-

try, we estimate the extra insurance premium tax that P-C insurance firms pay

by not locating in the state that minimizes their insurance premium taxes. We

find that only 4.78 percent of P-C firms are located in the state that minimizes

their insurance premium taxes. We explore the relationship between the extra

tax paid and other factors that are thought to be associated with firm location

choice. Wefind that P-C firms appear to trade off higher taxes to locate in a state

that is more urban.

INTRODUCTION

States tax insurance companies through premium taxes, which are essentially gross

receipt taxes on premiums written by insurance firms. But there is a unique feature of

premium taxes; namely, insurance companies pay the higher of the tax rate in the state

in which the company is domiciled and the tax rate in the state in which the policy

is written. Furthermore, there are substantial differences across states in the tax rates

imposed on insurance firms. These features of premium taxes provide a strong incentive

for an insurance firm to domicile in the state with the lowest premium tax rate among

the states in which it writes premiums.

While there is a large literature that explores the effect of taxation on income, employ-

ment, and business location,1no one has explored the extent to which individual firms

are located in the state that would, certeris paribus, minimize its taxes. We use a unique

database of individual property–casualty (P-C) insurance firms to explore whether these

Martin F. Grace is the Harry Chochran Professor of Risk at the Department of Risk, In-

surance, and Healthcare Management, Fox School of Business, Temple University; e-mail:

Martin.Grace@temple.edu. David L. Sjoquist is Professor of Economics at the Department of

Economics, Andrew Young School of Policy Studies, Georgia State University; e-mail: sjo-

quist@gsu.edu

1Wasylenko’s (1997) review, for example, referenced almost 100 articles and has been cited at

least 298 times.

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firms are domiciled in the state that minimizes their insurance premium taxes and

the extra tax they pay by not doing so. Our data set allows us to calculate the insurance

premium tax (which accounts for most of the subnational taxes levied on insurance

firms) that the firm would pay if it were domiciled in any of the 51 states, and were to

continue to generate the same premiums in each state. Wecan thus determine the insur-

ance premium tax liability that a firm could save by locating in the state that minimizes

its insurance premium taxes.2

There is a substantial literature that finds that taxes affect firm location choices (see,

e.g., Arauzo-Carod et al., 2010). However, firms do not necessarily locate to minimize

their taxes. Nonetheless, it is of interest to determine the additional, or extra tax, that

insurance firms pay because they do not locate in the state that minimizes their insurance

premium tax liability. The purpose of this article is to calculate the size and distribution

of the extra insurance premium tax that P-C firms pay and to explore the relationship

between the extra tax and other factors that are thought to affect firm location. We do

not attempt to determine the effect of taxes or other factors on the choice of location.

However, the magnitude of the extra tax paid implies something about the importance

of insurance premium taxes in the choice of location, although we cannot quantify the

size of that effect.

We conduct an analysis of the magnitude of the extra tax that P-C insurance firms pay

and find that a very significant percentage of P-C insurance firms are not domiciled

in the state that minimizes their insurance premium tax liability. We then explore the

relationship between factors thought to affect location choice and the magnitude of the

extra tax.

Little has been written on the economic effects of taxes as they relate specifically to the

insurance industry. McNamara et al. (2006) consider the effect of premium taxes on the

firm’s decision to relocate; their results indicate that firms relocating between 1989 and

1999 experienced an 8 basis-point reduction in premium taxes after the move. Wheaton

(1986) considers the impact of state taxes on the asset growth rates of the 77 largest

life insurance companies in the country. Grace and Yuan (2011) update the Wheaton

paper looking at the entire life insurance industry for a more recent time period and

find similar results. Petroni and Shackelford (1995) consider the effect of state premium

taxes and regulation on the choice of organizational form of P-C insurers. Finally, Grace

et al. (2014) explore the relationship between the size of a state’s P-C insurance industry

and the premium tax rate and find that the premium tax rate has a large negative effect

on the size of the industry in the state. To be clear, we are not estimating the effect of

insurance premium taxes on location choice, but on their willingness to, or tolerance of,

paying more taxes than they would if they relocated to the minimum tax state.

The remainder of the article proceeds as follows. The next section discusses the taxes that

P-C insurance firms pay, with a specific focus on the insurance premiumtax. The “Data

and Calculation of Extra Tax” section discusses the data we use and how we calculate

the extra tax paid, while the “Descriptive Analysis of Tax Liabilities” section presents a

2We are only considering the effect of a change in domestication on tax liability, and not on

profits. Certainly,a change in domestication could affect profits in ways other than a change in

tax liability, for example, it could change the wage rates and rental rates the firm faces and the

ability to hire workers with the requisite skills.