The Impact of State Taxes on Self-Insurance: Introduction

The second reason that no relation may be detected is that the demand for at least some forms of coverage may approach perfect inelasticity. If so, insurance rates will vary across states, but coverage will not vary. For example, automobile liability coverage is compulsory in 39 states. That is, consumers must choose between coverage and forgoing legal operation of an automobile. As a result, the demand curve for automobile liability coverage likely approaches vertical in compulsory states. Consistent with downward sloping demand curves, we find property-casualty insured losses in lines, other than automobile, are decreasing in insurers’ state tax burdens. This finding is consistent with state taxes suppressing property-casualty coverage. The result implies that tax planners are unable to eliminate state tax differences fully.
Additional tests that separately evaluate the two primary classifications of automobile insurance (liability coverage and physical damage coverage) further demonstrate that the relation between taxes and self-insurance varies with the elasticity of demand. Specifically, we find no relation between taxes and automobile liability insurance coverage, consistent with price inelasticity for mandated coverage. Conversely, consistent with a downward sloping demand curve for optional coverage, we find a negative relation between taxes and automobile physical damage insurance coverage. Further confirmation that taxes affect self-insurance is provided through an examination of workers’ compensation benefit payments.
To our knowledge, this is the first study to document that state taxes affect the insurance coverage in a state. The empirical link between taxes and consumer goods should aid in our understanding of the role of taxes in price formation. The paper also should interest policymakers, insurers, and consumer organizations because it calibrates the effects of industry taxes on self-insurance. For example, the primary empirical estimates imply that a 1 percent increase in the state premium tax rate reduces non-automobile insured losses by 0.18 percent to 0.28 percent. These elasticities suggest that for the mean state, a standard deviation increase in the state tax rate (0.5 percent) would lower insured losses by approximately $140 million or 7.5 percent of current coverage. The results imply similar increases in self-insurance for automobile physical damage coverage, but not for automobile liability coverage. Caution should be exercised in interpreting the findings in this paper. Theory is not rich enough to specify fully the interplay between states, insurers and consumers. Consequently, the tests rely on several key assumptions. The remainder of the paper is as follows: Section 2 sketches institutional background. Section 3 outlines the research design. Section 4 presents the empirical findings. Concluding remarks follow.