Association for Public Policy Analysis & Management

States use various mechanisms to stimulate economic development within their borders. Among them is discretion granted to counties and municipalities to levy special purpose taxes to fund economic development purposes. The most familiar of these is Tax Increment Finance districts, but there are various others as well. Texas permits municipalities to elect sales tax for economic development purposes, subject to local sales tax caps. In effect, municipalities that elect the 4a or 4b sales tax levy purposely allocate sales tax revenue toward community and economic development to the exclusion of other functional purposes. While such action may be symbolic for municipalities not fully utilizing their tax base, the action must be considered substantive for those that do.

Our research is concerned with the impact of these state tax policies, and local tax choices, on economic outcomes. Do municipalities that choose these special tax levies outperform their counterparts that do not? Using municipal data from Texas for the years of 2011 and 2015, the effect of taxes in 2011 is observed on a latent endogenous variable representing municipal economic growth between the years of 2011 and 2015. We utilize a structural equation model to estimate the effects of the 4a and 4b tax choices (or a combination of the two) on overall economic development, while simultaneously considering municipal socioeconomic status, population, property and sales tax revenue, and county-level opportunity index nesting effect for the 2011 year.

 Our results reveal that municipalities implementing both the 4a and 4b tax choices were associated with a significant and positive effect on economic development, which is measured across a series of indicator variables that include growth in population, median household income, property value, employment and the proportion of the population over the poverty level. The observed impact of the combined 4a and 4b tax choice is on par with 2011 population levels and only slightly less than 2011 municipal socioeconomic status. Our results, then, suggest that states are able to stimulate, or at least influence the location of, economic development activity within their borders by permitting municipal choice in the allocation of their tax revenues to support community and economic development purposes. By purposively pursuing economic development efforts to the exclusion of other governmental services and functions, cities seem to be able to develop financial and administrative capacity to realize improved economic development performance. Future research will investigate the specific mechanisms through which these effects are realized.