State Tax Policy, Municipal Choice, and Local Economic Development Outcomes: A Structural Equation Modeling Approach to Performance Assessment
| Published date | 01 May 2021 |
| Author | Jeremy L. Hall,David Z. Kanaan |
| Date | 01 May 2021 |
| DOI | http://doi.org/10.1111/puar.13165 |
Research Article
A Structural Equation Modeling Approach to Performance Assessment 459
Abstract: Do state policies that allow municipal governments to levy economic development taxes stimulate economic
development? Texas allows municipal-level economic development corporation dedicated local option sales taxes
(LOST), effectively diverting revenue from general fund purposes exclusively toward local economic development
efforts. Drawing from a performance management framework focused on policy outcomes, the authors use a structural
equation model to estimate the effects of local tax choices on economic development performance. The results reveal that
municipalities implementing the 4a LOST tax choice (traditional industry-related efforts) experienced a significant
and positive effect on economic development as measured through a latent construct assessing five years of growth
in population, property value, and new home construction. The observed impact of tax choice, though weaker than
preexisting municipal economic capacity, suggests that states and municipalities can influence economic development
activity by permitting municipal choice in the allocation of tax revenues dedicated to economic development.
Evidence for Practice
• Local option sales tax (LOST) choices can influence economic development outcomes, controlling for
preexisting economic capacity.
• Intergovernmental tax policy can be manipulated to permit localities to focus revenues on their strategic goals.
• Flexibility and/or deregulation allows resources to be shifted to functions that may influence growth and
government revenue at multiple levels.
• Preexisting capacity drives development more than the LOST choices, but LOST users backslide less than
their non-user counterparts.
• Municipalities adopting higher local option sales tax (LOST) rates for industrial development activities (4a)
realize increased economic development, whereas no change was detected with the adoption of LOST for
broader community development activities (4b).
Economic development has long been, and
continues to be, widely popular among elected
officials (Feiock, Lee, and Park 2012; Overton
2018; Parilla and Liu 2018; Thom 2018; Wolman
and Spitzley 1996). The nationwide competition
for Amazon’s HQ2 is the best recent example; as a
Brookings Institution report noted, “The incredible
volume of city bids, and the historic size of the
incentive packages, reflects not only the scale of the
Amazon investment, but the intense pressure that
economic development officials in U.S. cities and
states are under to deliver economic opportunity
in the face of widening socioeconomic disparities”
(Parilla and Liu 2018, 5). Amazon is a highly visible
example of the hundreds of competitions taking place
among states and localities at any given time.
This field of practice is also characterized by
considerable intergovernmental effort and interaction.
Fiscal decentralization and increased localization
of policy responsibility have amplified competition
among local governments to leverage economic
growth and development within their jurisdictions
(Kwon, Berry, and Feiock 2009). States use various
mechanisms to stimulate economic development
within their borders. Included among them is
discretion granted to counties and municipalities
to levy special-purpose taxes to fund economic
development purposes. While tax increment finance
districts are the most familiar of these (Bartels and
Hall 2012), there are various others as well. States
prefer costless approaches to stimulate development
when possible. That is, they develop permissive
policies that structure flexibility for local governments
to act, without any outlay of state funds. Special-
purpose sales taxes, also known as local option sales
taxes (LOST), are exemplary of such policies.
Studies of economic development have typically
explored the performance of specific strategies in
State Tax Policy, Municipal Choice, and Local Economic
Development Outcomes: A Structural Equation Modeling
Approach to Performance Assessment
Jeremy L. Hall David Z. Kanaan
University of Central Florida San Diego State University
David Z. Kanaan is chair of the Division
of Professional Studies at San Diego State
University, Imperial Valley. His research
interests include local government and
public education performance, economic
development, and state-level policy
effectiveness. Dr. Kanaan is assistant
professor of public administration and
managing editor of
Public Administration
Review
.
Email: dkanaan@sdsu.edu
Jeremy L. Hall is professor of public
administration in the School of Public
Administration at the University of Central
Florida and co–editor in chief of
Public
Administration Review
. His research focuses
on public management, evidence-based
practice, and state and local economic
development policy.
Email: jeremy.hall@ucf.edu
Public Administration Review,
Vol. 81, Iss. 3, pp. 459–474. © 2020 by
The American Society for Public Administration.
DOI: 10.1111/puar.13165.
460 Public Administration Review • May | Jun e 2 021
isolation; their focus is generally on direct outputs to avoid false
attribution of observed outcomes to the strategy when context
provides so many variables that are beyond control. Performance
management has shifted focus away from simple measures of
inputs (efficiency) and intermediate outputs toward a focus on
mission-oriented outcomes that characterize the policy’s or the
organization’s raison d’être. In similar fashion, the role of capacity
in generating performance improvements in public administration
generally (Andrews and Boyne 2010; Christensen and Gazley
2008; Christensen, Lægreid, and Rykkja 2016; Hou, Moynihan,
and Ingraham 2003) and economic development specifically
(Dincecco and Katz 2014; Hall 2008a, 2008b; Hall and Howell-
Moroney 2012) has been well established. Economic development
management and policy will be improved as they are increasingly
informed by evidence from scholarship that is focused not only on
outputs but also on outcomes against which to measure mission
achievement and that control for various forms of preexisting
capacity to measure the impact of particular strategies. This study
represents an effort to do so in evaluating the performance of Texas’s
LOST for economic development purposes.
Using municipal data from Texas for 2011 and 2015, the effect
of 2011 tax choices is observed on our latent endogenous variable
representing municipal economic development for 2011 and 2015,
allowing us to capture the change in development during that
interval. In Texas, municipalities are able to create, by referendum,
section4a and/or 4b economic development corporations
(EDCs) with an associated sales tax levy. Section4a is restricted to
traditional industrial development activities, whereas section4b
provides flexibility to fund those activities alongside more broadly
defined community development activities. We use a structural
equation model to estimate the effects of the 4a and 4b tax choices
(and rates) on overall economic development; simultaneously,
we consider 2011 municipal economic capacity as an exogenous
construct consisting of a county-level opportunity index nesting
effect, individual socioeconomic status, housing occupancy, and
property value per capita. Population control variables are also
considered. In other words, controlling for baseline economic
development levels, what effect did tax choices have?
To summarize, our research is concerned with the impact of these
state tax policies, and local tax choices, on economic outcomes.
The results provide valuable insight into the potential effects of
permissive tax policies and suggest that relaxed intergovernmental
regulation may afford the necessary flexibility to improve economic
performance. Our approach allows us to address two research
questions: Do municipalities that choose these special tax levies
outperform their counterparts that do not? And, how does
preexisting municipal capacity impact economic development?
Economic Development and Tax Policy
With the collaborative governance framework displacing unilateral
government action to solve problems in today’s society, the winner-
takes-all competitive attitude of local governments has never seemed
more out of place. Nonetheless, the work of economic developers
and public leaders is potentially constrained by a number of
historical structural and institutional frameworks. Overton (2018)
found that cities do compete; they pursue similar development
strategies as neighboring cities, with strategic differentiation
emerging as population heterogeneity and political and bureaucratic
incentives increase. While cooperation among jurisdictions can
bring tremendous benefits, competition and fragmentation can
make it a very risky endeavor (Feiock, Lee, and Park 2012).
Research has shown that state and local tax choices can influence
industrial and other economic activity (Kang, Reese, and Skidmore
2016; Thom 2018). Thom (2018) examined state incentives to lure
the motion picture industry away from California and New York,
finding small and mixed effects across a series of outputs, with no
effect on outcomes such as industry concentration or gross state
product. More directly relevant to this study, Overton (2018) found
that city reliance on sales tax as a source of revenue impacts the type
of development strategy a city pursues.
To local governments looking at options to promote economic
development, the LOST levies may appear as an opportunity;
whether proximity or similarity leads them to adopt (Berry and
Berry 1990) as part of a competitive race to the bottom is a lingering
question. Our focus is on the effects of such policies when adopted.
While LOST revenue and the creation of associated EDCs creates
capacity to stimulate development, it is also worthy of note that its
use increases tax complexity—a fact that may discourage firm location
as the compliance burden increases their costs (Sjoquist et al. 2007).
Research has found local government reliance on non-property-tax
revenue to be increasing since the 1970s, with states permitting
a wide variety of LOST options for their municipalities, ranging
from unlimited to highly restricted (Rogers 2004). A number of
studies have explored the use of LOST as a general-purpose tax,
including its influence on property and other tax types. Jung (2001)
found that the adoption of LOST in Georgia counties resulted in
reduced property tax rates, as required by law, but also property
tax relief. Rogers (2004) explored the particular effectiveness of
this tax mechanism with an eye toward the uniqueness of local tax
bases in Oklahoma—a state that permits unrestricted use of LOST.
She found that places with little urban influence may be able to
raise revenue as long as the tax rate was set very low, but places
with strong urban influence would be less able to increase revenue
through a rate increase. Texas cities are constrained to maximum
LOST rates for each tax and a 2 percent local cap on sales taxes.
Texas’s 4a and 4b programs have their origin in the Economic
Development Corporation Act of 1979. Initially, the focus of the
tax (section4a, 1989) was industrial development, but subsequent
revisions to the code provided an alternative (section4b, 1991)
with greater flexibility to fund activities associated with broader
community development, including museums, sports facilities,
tourism, housing, or water treatment (Peacock 2017). In addition,
municipalities choosing 4a corporations are limited to populations
under 500,000, whereas 4b corporation adopters can be of any size.
Type 4a corporations are specifically limited to using associated
LOST revenue to support land, buildings, equipment, facilities
expenditures, targeted infrastructure and improvements for projects
including the following:
• Manufacturing and industrial facilities, recycling facilities,
distribution centers, and small warehouse facilities
• Research and development facilities, regional or national
corporate headquarters facilities, primary job training facilities
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