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We provide theoretical and empirical evidence that ﬁrms do not in general respond equally to changes in prices and taxes in the setting of oil well drilling in the United States. Our key theoretical contribution is that in a multi-state model, a change in output price changes both the beneﬁt and opportunity cost of drilling, whereas a change in a state tax rate only changes the beneﬁt of drilling in that state. Thus, a ﬁrm responds more to a change in tax than a change in price. Our econometric results support this theoretical prediction. We ﬁnd that a one dollar per barrel increase in price leads to a 1 percent increase in wells drilled, but a one dollar per barrel increase in tax leads to at least an 8 percent decrease in wells drilled. These estimates correspond to elasticities of about 0.5 and -0.3, respectively. These results are robust to interstate spillovers, other state regulations, and econometric speciﬁcation. They imply that using state tax rate decreases to incentivize investment may lead to losses of government revenue.
JEL Classification: Q32, Q48, R51
Brown, Jason P., Peter Maniloff, Dale T. Manning. 2018. “Effects of State Taxation on Investment: Evidence from the Oil Industry.” Federal Reserve Bank of Kansas City, Research Working Paper no. 18-07, September. Available at External Linkhttps://doi.org/10.18651/RWP2018-07