Re: Setting up Regression

I would set up just a few variables:

Dependent variable, Y: growth in state GDP

independent variables:

X1: National GDP (controls for all exogenous variables)

X2: state tax rate

enter all your data for all 50 states for all available years (could be 500 observations for 10 years!). Y (state growth) = a1 + b1*National growth + b2*state tax rate. Coefficient b2 becomes the effect of the tax rate!

Re: Setting up Regression

Thanks for the reply.

So with the national GDP you don't see a need to include some sort of State variable in the regression?

Re: Setting up Regression

The state variable is already there! It is the tax rate. According to your hypothesis, two states with the SAME tax rate would have the SAME economic growth (more or less than the national average.)

Re: Setting up Regression

Actually, I might rethink that last post! There are other variables that would make a state perform better or worse than average (right to work, education level, etc.) Dummy variables would help capture those effects, sharpening the tax effect. I'd run it both ways and see what happens. I might also include a sales tax variable. And finally, watch out for lag effects.