Title

The impact of government policies on the location decisions of new business

Date of Award

2009

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Department

Economics

Advisor(s)

Stuart Rosenthal

Keywords

Government policies, Location, Minimum wage, New business, Empowerment Zone

Subject Categories

Economics | Social and Behavioral Sciences

Abstract

This dissertation consists of three essays on the impact of government policies on the location decisions of new businesses. The first essay examines the degree to which changes in state minimum wage rates affect the state in which entrepreneurs choose to locate their businesses. The last two essays examine the impact of the Federal Empowerment Zone program on establishment location and employment. The second essay examines the potential for location-based tax incentives, such as Empowerment Zones, to have a differential effect on establishment location and employment across industry sectors. In the final essay, my co-author and I test the degree to which the Federal Empowerment Zone program attracts new business establishments to the designated geographic areas.

The first essay examines the impact of state minimum wage rate changes on where entrepreneurs choose to locate their business in areas along state borders. Using GIS software, the analysis focuses on activity within one mile of state borders and utilizes two levels of differencing to identify effects, cross-border differences and differences between the two sample years. The analysis also allows for differences in impacts across different one-digit industries. The difference-in-differences methodology in conjunction with a border approach controls for unobserved area characteristics that would otherwise confound the impact of minimum wage rates. Controlling for unobserved factors has been a central challenge in previous research on the minimum wage, and has also hampered prior efforts to identify the impacts of local business policy on business location decisions.

Results from the first essay indicate that an increase in the state minimum wage has a small negative impact on new business activity when pooling all industries together. Further analysis reveals substantial differences in the sensitivity to state minimum wage across one-digit industry groups: minimum wage effects are most pronounced negative impacts in manufacturing and retail. Results also indicate that sensitivity to the minimum wage increases with the degree to which an industry relies on workers with less than a high school education: the response of new business activity to a one dollar increase in the minimum wage is 7 percentage points higher among two-digit industries most reliant on low-skill workers as compared to industries that employ few workers with a limited education. These findings indicate that close to state borders, entrepreneurs are responsive to differences in the minimum wage changes, and especially so in industries that rely heavily on low-skilled workers.

The second essay examines the potential for location-based tax incentives to have a differential effect on establishment location and employment across industry sectors. My co-author, Andrew Hanson, and I use a simple model to show the differential effect of the location-based federal Empowerment Zone (EZ) wage tax credit on equilibrium labor and total cost savings across industry sectors. The predictions of this simple model guide our empirical work as we use the assignment of the federal EZ to test the effect of the program on employment and location of firms across industry sectors. Our empirical analysis shows that the location based-tax incentive had a positive effect on firm location in some of the industries our model predicts and a negative impact in industries that could be crowded out by those that benefit more from the tax incentive. We estimate that in the short-term the federal EZ program increased the share of firms in designated areas in the retail and service industry by between 0.16 and 0.30 percentage points and reduced the share of establishments in the transportation and finance, insurance and real estate industry by between 0.16 and 0.19 percentage points. The long-term effect of the program is to replace firms in the transportation industry with those in the retail industry, although these effects are less precisely estimated.

The third essay examines how offering employment based tax incentives in a local area affect the entry of new establishments in the area. Andrew Hanson and I use the federal Empowerment Zone (EZ) tax incentive, the largest employer-based wage tax credit in the federal tax code, as a natural experiment to test this relationship. Our results show that offering a tax credit that is tied to local geography reduces the number of new establishments in the targeted area by almost 74 percent in the short-term. The negative result is persistent across industry types, and is driven by the substantial negative effect on small establishments (between one and four employees). We also find that the negative effect of the tax incentives persists in the longer term. The sign of our primary results is robust to an alternative instrumental variables specification, however the statistical significance is not. We show evidence that the negative result for new businesses is driven by the expansion of establishments that were in the targeted area prior to the tax incentives being offered, and is consistent with the capitalization of the incentives into property values. We do find some evidence that the tax incentives worked to attract new establishments in industries for areas that had some existing agglomeration of establishments, however these results are quite imprecise.

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