Question

2. (6 points) States that have control over taxation sometimes reduce taxes in an attempt to spur economic growth. Suppose that you are hired by a state to estimate the effect of corporate tax rates on the growth in per capita gross state product (GSP)? a. What kind of data would you need to collect to undertake the necessary statistical analysis? time series b. Is it feasible to conduct a controlled experiment? What would be required? C. Is a correlation analysis between GSP growth and tax rates likely to represent a convincing policy recommendation? Briefly explain why or why not?

Answer 1

Part 1

For best results one must always collect more than 30 to 40 observations (to get some what accurate results)

Secondary Data set, and should be picked from a reliable source such as your countries statistical board's website. You should consider ,multiple variables for better results. Just test for collinearity of data base (or unit root test before starting)

Data set

1. GDP growth data
2. Corporate tax rates
3. Increased consumption (consumption data set)
4. Increase domestic and foreign capital investment ( to see if reduction in corporate taxes has increased investment or not)
5. Wage Rate ( To test any increase in wage levels )
6. Effective marginal tax rate ( you can get these calculated at some sources or you can calculate on your own)
7. Can use a dummy variable for any kind of shock in he economy ( like global turn down)

​ Part 2

Controlled experiments have their own draw backs.

If there are tax changes that arise tax changes arise for reasons other than the condition of the economy like I mentioned global turndown earlier---- these are like external shocks or exogeneous variables. And in a controlled experiment environment impact of these variable will be lost and the study will not be hollistic enough. Also one should note that these sorts of plausibly exogenous tax changes have quite significant macroeconomic effects.

Plus there might be reverse causation as well. As in when economic growth starts impacting the corporate taxes. This effect is also to get lost in the case. One way is to introduce dummy variables for majorly traceable exogeneous shocks etc.

Part 3

Technically NO.

This is because the main agenda of the test here is that how much does GSP gets effected if there is a change in corporate taxation. What is required to show is that if a lowering of corporate taxation going to trigger the capital gross product. (Some effect similar to the laffer curve, only in this the taxes payable by the people increases as tax rate falls to an optimal level).

A correlation test however just is limited to the field of how one variable is related to the other variables. A correlation equation will just give how much two variable relate.

CORRELATION does not show nor illustrate causation, meaning that it does not prove that one variable causes the other. And in this case what's required to show is that a fall in corporate tax is the CAUSE for the GSP TO RISE (EFFECT)