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State taxation of energy production:
Regional and national issues
Bankers disagree on the path
to interstate banking
Economic recovery and jobs
in the Seventh District
Did usury ceilings hold down
auto sales?

Sep tem b er/O ctob er 1984
Volume VIII, Issue 5
E d ito r ia l C o m m itte e

vice president and
associate director o f research
Randall C. Merris, research economist
Edward G. Nash, editor
Harvey Rosenblum,

assistant editor
editorial assistant

Roger Thryselius,
Nancy Ahlstrom,
Christine Pavel,
Gloria Hull,

Econom ic Perspectives is
published by the Research Department of
the Federal Reserve Bank of Chicago. The
views expressed are the authors’ and do
not necessarily reflect the views of the
management of the Federal Reserve Bank
of Chicago or the Federal Reserve System.
Single-copy subscriptions are avail­
able free of charge. Please send requests
for single- and multiple-copy subscrip­
tions, back issues, and address changes to
Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois 60690, or telephone
(3 1 2 ) 322-5111.
Articles may be reprinted provided
source is credited and Public Information
Center is provided with a copy of the
published material.

ISSN 0164-0682

C o n ten ts
State taxation o f en ergy production:
Regional and national issues


When the "haves” tax energy, they strike a
nerve in the “have-nots” and alter the
national economy in often subtle ways.

Bankers disagree on th e path
to interstate banking


E con om ic recovery and jobs
in th e Seventh District


Did usury ceilings hold down
auto sales?


At the 1984 Bank Structure Conference,
a panel of bankers aired differing views
in a spirited discussion on how to
get to interstate banking.

Policymakers are beginning to look
for reasons why the Midwest
is bouncing back less vigorously
than other parts of the country.
Interest rate lids were supposed to
protect consumers, but they may also
have reduced available credit and
blocked potential sales.

S tate ta x a tio n o f e n e rg y p ro d u ctio n :
re g io n a l a n d n a tio n a l issu es
William A. Testa
Among the many aspects of domestic U.S. energy
policies that have proved divisive, the taxation of
energy7production by energy-rich states incites
especially sharp regional hostilities. Climbing
prices of oil and natural gas, along with increas­
ing production of Western coal, have given rise
to large wealth flows via energy taxation from
energy-consuming regions to energy-producing
regions, aggravating existing trends in this direc­
tion. Regions that do not fare well from energy
taxes harbor resentment against neighbor states,
who are perceived as adding insult, if not further
damage, to their injuries. Meanwhile, energyproducing states regard their tax revenue wind­
falls as compensation for growing public service
accommodations, environmental damage, and
future costs of exhausted resource development.
In addition to redistributing wealth among
regions, aggressive energy taxation by energyproducing states (along with other energyrelated revenues) changes the location of
employment and population in favor of these
states. To some degree, this migration of jobs and
people furthers existing migration from older
industrial areas (w hich tend to be energy­
consuming states) toward growing areas. Energy­
consuming states are particularly sensitive to
energy-related fiscal moves by other states b e­
cause such actions are perceived as luring
employment away from their own depressed
How en erg y ta x revenues redistribute
region al in co m e
Taxes levied on an econom ic activity in a
state can, under some conditions, burden resi­
dents of another state. The tax burden is then
said to be exported out of state. In the present
context, residents of energy-producing states
William A. Testa is a regional economist at the Federal
Reserve Bank of Chicago.

Federal Reserve Bank o f Chicago

benefit from consumption of public services that
are paid for elsewhere.
When a tax is imposed on an economic
activity such as energy production, the resulting
revenue will ultimately be paid by producers,
consumers or, more than likely, some combina­
tion of these market participants.1The consum­
er’s burden of energy taxation reflects the ability
of producers to raise their product price to
accommodate taxation. However, this ability to
pass price increases forward to consumers is
limited because consumers can turn to alterna­
tive suppliers of substitute goods rather than
submit to higher prices. As a result, some portion
of energy tax revenue derives from lower profits
of owners of mineral rights, lower rates of return
to capital owners of energy-producing equip­
ment, and lower wages of energy-industry labor.*
Although the actual division of this tax
burden is difficult to measure, it is widely
believed that severance taxes are largely ex ­
tracted from econom ic rents on energy prod­
ucts, especially petroleum and natural gas, which
would otherwise accrue to owners of mineral
rights. The recent run-up in world energy prices
has yielded large economic rents or profits to
owners of mineral properties. And because
energy prices for some fuels are set on world
markets, they cannot be changed by a small seg­
ment of the production market. This may be less
true for energy materials with special features,
such as low-sulfur Western coal, because a few
states dominate production while the utilities
'Tax burden may also be borne by factors of production
in economic activity such as labor and capital. This “back­
ward shifting” of taxes is generally inferred from a general
equilibrium model of market activity. For example, see
Albert Church,
ington, Mass., 1981.

Taxation o f Nonrenewable Resources,

2The process by which the tax burden is shifted from
producers to consumers may result in a burden or economic
incidence that differs from the intended or statutory inci­
dence. See R. A. Musgrave and P. B. Musgrave,
3rd ed., New York, 1980.

in Theory and Practice,

Public Finance


that consume these products cannot easily switch
fuels in response to a price increase.
Regardless of the relative weight of taxation
between producing and consuming segments of
the energy industry, the tax burden on energy
production may be exported to consuming
states. If energy production taxes are shifted
forward to consumers through increases in the
price of energy products, residents of consum­
ing states suffer a loss of income. Those few
states producing the bulk of domestic energy
production consume only a portion of their
energy-product (Table 1). More than one-half of
the domestic production of each of the three
major domestic energy materials—natural gas,
coal, and petroleum —is produced by fewer than

T a b le 1
P rod uction s h a re and n et e x p o rt position
by m a jo r fuel in leadin g sta te s , 19 8 1
share of

Production to

(percent value
of product)

unit base)

Natural gas
New Mexico




Crude petroleum




W. Virginia




SOURCE: S tate Energy Overview, Energy Information Administration,
U.S. Department of Energy, DO E/EIA - 0354 (82), 1983.


five states.3 These producing states export more
than they consume. Tax levies are exported
along with energy products to the extent that
the consumer price rises in response to taxation.
Even if energy tax burdens are borne by the
producing segment of the industry, energy states
can conceivably export the tax burden to con­
suming states. To the extent that equity values
decline in response to energy taxation, the por­
tion of equity wealth that would otherwise
accrue to owners living in energy-consuming
states will now be redistributed to producingstate residents in the form of greater public
goods consumption, lower state taxes, or some
combination of these windfalls.
By exporting tax burdens to other states
(and, thus, importing revenues), energy produc­
ing states may also benefit from federal grants to
state and local governments. Federal grants, such
as revenue sharing, often distribute aid on the
basis of some measurement of a state’s current
effort in taxing the income and property of its
own residents. Insofar as the tax revenues col­
lected from out-of-state residents are mistakenly
counted as a drain on state residents in federal
grant formulas, energy-producing states and their
residents receive fiscal windfalls from both energy
taxes and favorable grant allotments.
P rod u cer state response
Representatives of energy-producing states
readily deny that tax revenues from energy pro­
duction increase the general welfare of their
citizens. Their arguments suggest that energy'
rev enues merely compensate for costs imposed
on a state’s government and citizens through
increased state and local government costs,
environmental damages, and such intangibles as
the degradation of former lifesty le that may
’These production totals are somewhat misleading
indicators of tax export ability because they include coastal
production beyond state boundaries. Although this produc­
tion activity is closely tied to state economies, no state
revenues accrue from production.
Uranium production totals by state are not available due
to corporate disclosure problems. Nuclear power consump­
tion accounts for 3-5 percent of total domestic energy' con­
sumption and 5.2 percent of the Seventh District regional

Economic Perspectives

accompany population migration from other
With regard to increased government costs,
producer states maintain that, although the state
tax base increases with in-migration of business
and population, service costs rise at an equal or
greater rate for several reasons. Large front-end
costs of financing new capital infrastructure
such as roads, sewers, schools, and sewer sys­
tems are required. In addition, debt financing
during periods of high interest rates can be
especially burdensome. Finally, these states main­
tain that, because energy sources will soon be
exhausted, the boom-towns of today will even­
tually leave behind large pockets of unemployed
persons who consume public services in amounts
greater than their tax contributions. For this rea­
son, producer states argue that fiscal windfalls of
today should be placed in state trust funds to
cover these future costs. Several energy-produc­
ing states have established such trust funds.
A second set of related costs of energy pro­
duction are environmental damages. For exam­
ple, to the extent that state residents bear energy
production costs in the form of the erosion of
Louisiana’s wetlands and the denuding of Wyo­
ming’s and Montana’s Powder River Basin, the
concept of tax exporting and regional tax inci­
dence must be redefined to include both bene­
fits and costs of hosting energy production activ­
ities.4Although environmental damages are more
difficult to quantify, these costs can nonetheless
be substantial.
How en erg y ta x e s ch an ge th e regional
locatio n o f e co n o m ic activity
If energy tax burdens are, in fact, exported,
or if in state federal grant allotments are raised,
real income will be transferred to producing
state residents via some combination of lower
individual tax burdens and greater consumption
of public services. Insofar as the income transfers
accrue to initial state residents and immigrants
alike, population and employment can be ex­
pected to follow these fiscal advantages.
♦This concept has been referred to as “net incidence.”
See R. A. Musgrave and P. B. Musgrave,
, 2nd ed., New York, 1976.

Theory and Practice

Public Finance in

Federal Reserve Bank o f Chicago

An economic incentive for population migra
tion arises from tax exporting because immi­
grants are able to pay lower taxes and/or con­
sume greater public services by migrating. Some­
what less apparently, nonenergy-producing in­
dustrial and com m ercial firms located in
energy-producing states can also benefit from
tax exporting. A declining tax share in a produc­
ing state lowers costs and increases profitability
to firms in these locations. Moreover, it may be
less costly to attract skilled workers to these
locations from a national labor market because
net-of-tax salaries are increased through lower
state taxes on individual income. Finally, state
fiscal windfalls can alternatively subsidize busi­
ness services rather than publicly provided con­
sumer goods. Such public inputs to private
market production as dams, waterways, airports,
and education encourage regional industrial and
commercial development, perhaps partly at the
expense of competing regions.
National co n ce rn s
Fiscally-induced incentives to relocate eco­
nomic activity may reduce the overall productiv­
ity of the economy. The econom ic notion of
national production efficiency suggests that in a
free market the productivity of marginal units of
any input to production, such as labor or capital,
should be equal in all uses. In a regional context,
the productivity of an additional unit of an input
must be equal in every location to insure maxi­
mum production from limited resources. Nation­
al markets for labor and capital produce this
result by tending to equalize wage costs and
interest rates across regions. However, if state
governments use fiscal windfalls to subsidize
migrant labor or capital, these inputs relocate in
response to pure fiscal reasons rather than to the
price signals of the free market. As a result, productitivy of labor and capital will differ across
regions. This may be less than optimal because a
different spatial arrangement of available firms,
capital, and labor might increase national income
and production.
A second national concern over state energy
revenues involves the equity of fiscal disparities.
Through programs such as General Revenue

Sharing, Congress has attempted to mitigate fis­
cal disparities between regions of the country. In
debates over these programs, the issue of tax
exporting has arisen in response to rising energy
taxes. To the extent that grant formulas that are
intended to equalize fiscal disparities actually
aggravate them by neglecting the effects of
energy tax exporting, federal amendment of
exisiting grant formulas may need to be consid­
ered. Recognition of tax exporting in grant for­
mulas would require accurate measurement of
tax exporting for all state revenue sources in
addition to severance taxes, a difficult adminis­
trative and econom ic problem.1
Another national concern over energy taxa­
tion has arisen from attempts by the congres­
sional delegations of some energy-consuming
states to limit the power of energy-rich states to
capitalize on their advantages. The federal
government can potentially override state poli­
cies, if they are detrimental to national interests,
through its constitutional powers to regulate
interstate commerce. Congressional bills have
already appeared that limit the power of states to
tax energy materials and to establish national
taxes on energy production, though none have
been committed to law. Enactment of such bills
might have grave consequences for the stability
of our federal system. Under the Constitution,
the power to tax within its own borders is
reserved to the states. Curtailing the power of
states to enact severance taxes could establish a
dangerous precedent and alter existing federalstate relationships. Escalating retaliation among
regions of the country in usurping other state tax
bases through Congressional legislation could
upset fiscal stability within many states in the
State revenues
While regional and national attention has
focused on the issues concerning fiscal dispari­
ties between have and have-not states, these dis­
5For a discussion of the problems inherent in measuring
tax exporting, see Charles E. McClure, “Tax Exporting and
the Commerce Clause,”
, Charles E. McClure and Peter Mieszkowski, eds., Lexington, Mass. 1983-

o f Economic Resource

Fiscal Federalism and the Taxation

parities are not well documented. In part, this
reflects the fact that state energy revenue
sources assume many forms, such as severance
taxes, property taxes, corporate income taxes,
production privilege fees, royalties on state
lands, favorable federal grant allotments, and inlieu payments to states from federal onshore
land in production. Moreover, insofar as these
revenues have only recently becom e important,
much of the public remains unaware of their
magnitude—an average $220 per capita and 30
percent of state tax revenues in the major
energy-producing states in 1983Severance taxation
The severance tax, also referred to as a pro­
duction tax, production privilege tax, or a con­
servation tax remains the most widespread and
highest-yielding energy tax. The key characteris­
tic of this tax is that payment occurs when the
product is taken from the soil or shortly there­
after. The Census Bureau defines severance
taxes as:
T a x e s im p o s e d d is tin c tiv e ly o n r e m o v a l o f
n a tu ra l p r o d u c t s — e .g ., o il, g as, o t h e r m in ­
e ra ls , tim b e r , fish, e t c . — fr o m lan d o r w a te r
a n d m e a s u r e d by v a lu e o r q u a n tity o f p r o d ­
u c ts re m o v e d o r s o ld .5

Although these taxes are levied on a great variety
of minerals, state revenue from taxes on petro­
leum and natural gas greatly exceeds that from
all other sources, accounting for an estimated 84
percent of severance tax revenues in 1980.7*
Revenues from coal production amount to
another 8 percent.
Over the last decade, state severance tax
revenue grew rapidly in constant dollar terms
(Figure 1). Severance tax revenue increased by
approximately 291 percent from fiscal year 1973
(th e year before the OPEC embargo) through
fiscal year 1983, an average annual growth rate of
13-6 percent. In fiscal 1983, states raised over $7

bState Government Tax Collections In 1982

, Bureau of
the Census, U.S. Department of Commerce, Series GF82 No.
1, p. 38., U.S.G.P.O., 1982.
’ See Peggy Cuciti, Harvey Galper. and Robert Lucke,
“State Energy Revenues,”
, Charles E. McClure and Peter
Mieszkowski, eds., Lexington, Mass., 1983. p 18.

Fiscal Federalism and the Taxa­
tion o f Natural Resources

Economic Perspectives

tion and partial decontrol of natural gas, signifi­
cantly boosted these tax revenues. From 1977 to
1983, total severance tax revenues more than
doubled in real terms.
Severance tax revenues have become a
much more important revenue source to state
governments, climbing from 1.3 percent of
overall state tax revenue in 1973 to 4.3 percent
in fiscal 1983- Although this is not a large frac­
tion of overall state tax revenue, severance tax
revenue became a mainstay of the fiscal system
for many individual states over this period (Table
3 ). In 1970, only one state ( Louisiana) relied on
the severance tax to provide more than one-fifth
of tax revenue. By 1983, eight states—Texas,
Louisiana, Alaska, Oklahoma, New Mexico, Mon­
tana, Wyoming, and North Dakota—relied on
severance revenues for tax shares of this size.

Figure 1

Severance tax revenue in the U.S.
millions of 1983 dollars

billion in revenues from the severance tax alone
(Table 2).
In large part, price hikes for petroleum and
natural gas explain rising tax revenue in the Uni­
ted States, beginning with the first OPEC-related
price increases in 1973-74. Rising production of
coal in Western states, accompanied by aggres­
sive tax policies, also contributed to rising
revenues. Most recently, the OPEC price increase
following the Iranian revolution, coupled with
price decontrol of domestic petroleum produc-

T ab le 2
S e v e ra n c e ta x re v e n u e s in th e U .S .,
fisc a l y e a rs 1 9 7 3 to 1 9 8 3


$ millions)


$ millions)



of state
tax revenue


Texas raised over $2.2 billion in severance
tax revenue in 1983, almost one-third of all
domestic severance tax revenue. Alaska and
Louisiana together accounted for another onethird of total severance tax revenue. On a per
capita basis, the nine leading severance tax states
collected around $220 per capita in fiscal year
1983, with a wide dispersion around this average
(Figure 2). The State of Alaska, with its huge
petroleum resources and sparse population, col­
lected approximately $3,365 per capita from
severance taxes alone in 1983.
Severance tax revenues were affected by the
1982 recession. Across the United States, they
fell by more than 5 percent from fiscal 1982 to
1983- Each of the top severance tax states also
suffered declining real revenues over this period,
suggesting that such revenues are a highly vola­
tile source of revenue.
Royalties, rentals, and bonus paym ents

State governments collect rentals and frontend bonus payments from mineral production
on state-owned land in much the same manner
as private land rental rights are determined, by
two-party negotiation. Royalty or rental rates
vary by the value of extracted material and cost
*Revenues are inflated by the implicit price deflator for state and
of extraction. Although aggregate estimates of
lo c a l p u r c h a s e s o f g o o d s a n d s e r v ic e s (1 9 8 3 =
1 0 0 ).
these revenues are not available, the U.S. Advi­
S O U R C ETax: C o lleSc tiot n s , t G e o v e r n m e n t s D i v i s i o n , B u r e a u o f
t h e C e n s u s , U . S . D e p a r t m e n t o f C o sory Commission on Intergovernmental Relam m e r c e .

Federal Reserve Bank o f Chicago

T a b le 3
S e v e r a n c e t a x r e v e n u e b y s t a t e , f is c a l y e a r s 1 9 7 3 a n d 1 9 8 3

Share of state
tax revenue




New Mexico
North Dakota
Nine State Total
United States




(p e rc e n t)


Real revenue
per capita

Real revenue




($ )

m illio n s )



NOTE: Revenues are inflated by the implicit price deflator for state and local purchases of goods and services,
1983 = 100. Per capita revenues are derived from July 1 population estimates of the Bureau of the Census, Series
Commerce, and

, Governments Division, Bureau of the Census, U.S. Department of
, Series P-25, Population Division, Bureau of the Census.

S t a t e G o v e r n m e n t F in a n c e s
C u rr e n t P o p u la tio n R e p o r ts

tions estimates that revenue from mineral leases
grew from $500 million in 1972 to $3 3 billion in
fiscal 1980.8 From year to year, these payments
average three-fourths as much as state severance
tax revenues.
Royalties paid to the federal government for
production on onshore federal lands are widely
shared with states. About 20 percent of the
national total of state royalty revenue is com ­
prised of federal revenue. New Mexico and
Wyoming are reported to receive two-thirds of
this federal-source income.9 Coal development
of the Powder River Basin in Wyoming and Mon­
tana is expected greatly to increase these federalsource monies in the coming decades.
Although royalty revenue data are not widely
reported on a national basis, certain states are
known to collect substantial revenues. Once
again, Alaska stands out as a primary collector of
revenues. All petroleum production in Alaska
occurs on state lands and is subject to a royalty
rate of one-eighth of value. For fiscal year 1982,
"Ibid., p. 239See Peter Mieszkowsld and Eric Toder, “Taxation of
Energy Resources,”
, p. 76.

Natural Resources


Fiscal Federalism and the Taxation o f

Alaska collected nearly $1,557 million in natural
resource royalties, a figure that exceeded its sev­
erance tax revenue (Table 4 ). Royalties in com ­
bination with severance tax revenues accounted
for over 50 percent of Alaska’s revenue from all
sources in 1983, more than $6,000 per capita.
O ther m ethods o f taxation
Aside from royalty fees and severance taxes,
producing states maintain other taxes to collect
revenues from energy production. These revenue
sources are often less visible and include state­
wide property taxation, local property taxation,
corporate income taxation, and gross receipts
For some taxes, especially the state corpo­
rate income tax, it is often difficult to identify
those revenues that are related to energy pro­
duction. Corporation tax revenues by industry
are not generally reported by state governments.
Alaska’s use of separate accounting of petroleum
industry profits, effectively repealed on January
1,1982, was an exception. Most states apportion
the taxable income of corporations among states
using a three-factor formula that includes the

Economic Perspectives

Figure 2
P e r capita s e v e ra n c e tax re ve n u e s from all sources

(in dollars— fiscal year 1983)

state’s share of corporate payroll, property, and
sales. In an apparent attempt to increase its
revenues from energy corporations, Alaska
treated corporate energy production activities
as separate entities in determining income earned

T a b le 4

N a tu ra l re s o u rc e re n t and ro y a lty re v e n u e ,
s e le c te d s ta te s , fiscal y e a r 1 9 8 2
Rents and
($ thousands)
New Mexico

* P e r
1 9 8 1 . M
A p r il 1,

Per capita rents
and royalties*
($ )



c a p it a
fi g u r e s
u s e
r e s id
o n t a n a 's r e v e n u e fi g u r e s
1 9 8 0 .

S O U RS taCte G o v: e rn m e n t F in a n c e s in 1982, B u r e a u o
s u s , G o v e r n m e Cnu rre ns t P oDp u la tio ni sR ei poo rts , , S a e n r d i e s
# 9 4 4 , B u r e a u o f t h e C e n s u s .

Federal Reserve Bank o f Chicago

in Alaska, imposing a special 9.4 percent tax rate.
Prior to its effective repeal in 1982, Alaska col­
lected $669 million in fiscal 1982 from energy
corporations under this system.
Taxation of property value at the state or
local government level can also substitute for, or
augment, other energy revenues. Alaska levied
the only statewide property tax on oil and gas
property in fiscal 1983, collecting over $152
million. At the local level, some states, such as
Louisiana, Oklahoma, and Alaska, exempt land
under production from the local property tax
while other states, such as Texas and California,
reportedly attempt to tax the true market value
of energy reserves underground. Some energyproducing states that do not raise substantial
energy revenues from severance taxes may do so
e n t
p o p u la t io n
e s t i m a t e s
f o r
J u ly
a r ethrough f some form aofr property, taxation.l aWest n
f o r
i s c a l y e
1 9 8 1
p o p u
t io
Virginia, Virginia, and Pennsylvania rank very low
f t h in severance tax revenues, yet coal property
e C e n ­
P - 2 5 ,
within these states is subject to some form of


1 ,
f o r

local property tax. Here again, revenues by
industry are not available. Mieszkowski and
Toder (1 9 8 2 ) estimate that Texas property tax
revenues from oil and gas properties may have
amounted to as much as $775 million in fiscal
year 1981.10

residents, it would amount to approximately 3
percent of personal income in most energy
states, but over one-third of personal income to
residents of Alaska.

Total en ergy revenues

Consuming states have acted on their con­
cerns over real or perceived income transfers to
energy-producing states in the state and federal
legislative arenas as well as within the federal
judicial system. State legislatures in Connecticut
and New York have attempted to capture some
portion of energy corporation profits by impos­
ing gross receipts taxes on sales of products.
These practices stood little chance of success so
long as energy companies could escape the tax
burden by raising prices to consumers in those
states. In response, Connecticut and New York
tried to prohibit price increases following the
imposition of taxation. Federal courts, however,
struck down such measures as interfering with
the sovereign federal power to regulate inter-

The total energy revenues collected by
energy-producing states remain unknown, but
severance taxes plus royalty fees suggest some
approximate levels. The leading energy-produc­
ing states collect, on average, three to four
hundred dollars per capita per year from sever­
ance taxes and royalties. Alaska is a notable
exception, capturing $6,000 to $7,000 per capita.
As a point of comparison, per capita per­
sonal income averaged $11,000 to $12,000 in
1982-83. If royalty and severance tax monies
comprised a pure subsidy to producing state
l0Ibid., p. 74.

C onsum er state actions

Severan ce taxatio n in Seventh District states
A lth o u g h a re la tiv e ly fe w s t a te s c o l l e c t th e

$ 8 1 m illio n o r 1 .2 p e r c e n t o f th e s t a te ’s ta x r e v e n u e

b u lk o f s e v e r a n c e ta x e s , 3 2 s ta te s e m p lo y s e v e r ­

in 1 9 8 3 - In d ia n a le v ie s a s m a ll p e r c e n t a g e t a x o n

a n c e t a x e s in o n e

o r a n o t h e r . M ic h ig a n

p e tr o le u m an d W is c o n s in c o l l e c t s m o d e s t r e v e n u e s

im p o s e d th e first s e v e r a n c e t a x , o n ir o n o r e , in

fr o m t im b e r p r o d u c t io n . Illin o is, t h e r e g i o n ’s la rg ­

1 8 4 6 . T o d a y , M ic h ig a n ra is e s t h e o n ly sig n ific a n t

e s t e n e r g y p r o d u c e r , h a s n o s e v e r a n c e t a x o n its

s e v e r a n c e t a x re v e n u e w ith in th e S e v e n th D is tric t,

c o a l p r o d u c tio n .

fo rm

S e v e r a n c e t a x r a t e s a n d r e v e n u e w ith in S e v e n t h D is t r ic t s ta t e s , 1 9 8 3

Tax rates

Natural gas


Revenue from all
severance taxes

Share of
state taxes

(th o u s a n d s

(p e rc e n t)


(p e rc e n t)

o f d o lla rs )






0 .0


SOURCE: State Tax Guide, Commerce Clearinghouse Corp., and State Government Tax Collection in 1982, U.S.
Bureau of the Census.



Economic Perspectives

state com m erce.1
State revisions of their own corporate in­
come taxes have increased consuming-state reve­
nues from multi-state and multi-national energy
firms. Through the “unitary business method,”
the combination of interstate and worldwide
energy company subsidiaries, states such as Cali­
fornia and Florida have pulled the profitable
energy production and transport linkages of
energy industries into the state corporate income
tax base.
Consuming states have experienced favor­
able judicial rulings for these practices. In E xxon
v. W isconsin, the corporation maintained that its
domestic distribution subsidiary was a separate
entity from its exploration and recovery opera­
tions.1 The U.S. Supreme Court rejected these
arguments in favor of the unitary business ap­
proach to business taxation. More recently, the
Supreme Court removed any doubt that it might
decide that worldwide combination of corpo­
rate subsidiaries is unconstitutional.1 Following
this ruling, Florida adopted worldwide combina­
tion and apportionment of income. However,
states are now proceeding cautiously in adopt­
ing worldwide unitary methods because this
practice has been vigorously protested by many
firms as detrim ental to a state’s “business
Consuming states have attempted to thwart
producing state use of severance taxation by
appealing to the com m erce clause of the U.S.
Constitution which grants to Congress “power
to regulate com m erce with foreign countries,
and among several states, and with the Indian
Tribes.”14* Although the method and circum­
stance of such regulations are not contained in
the Constitution, federal courts have continually
disallowed taxes that discriminate against goods
on the basis of their movement across state
borders. States do not have the power to discrim­

Mobil Oil Corp. Tully, 499F. Supp. 888,892
Mobil Oil Corp. v. Dubno, 492F Supp.

1 See
(N.D.N.Y.1980) and
1004,1006 (D. Conn. 1980).

12Exxon Corp. v. Wisconsin Dept, o f Revenue, 44 F U.S.

2 0 7 (1 9 8 0 ).

13Container Corp. o f America v. California State Fran­
chise Bd., 77 L. Ed. 2d 545 ( 1983).
•'Article I, Section 8., U.S. Constitution.

Federal Reserve Bank o f Chicago

inately tax exports or imports of another state or
foreign nation. If Illinois, for example, levied a
state sales tax solely on foreign autos or on Cali­
fornia wine, it would most likely be found in
violation of the commerce clause.
In this regard, a number of coal companies
and their out-of-state utility customers filed suit
alleging that Montana’s 30 percent severance tax
on coal discriminated against interstate com ­
merce because the tax was not fairly related to
the services and protection provided by the
state.1 Among the complex legal arguments, the
claimants contended that the tax unconstitu­
tionally represented a tax on exports from that
state because revenues exceeded perceived costs
of extraction imposed on the residents of Mon­
tana. The U.S. Supreme Court ruled that this tax
was not discriminatory in that it taxed severance
of coal from the soil irrespective of its destina­
tion. The majority opinion stated:
. . . t h e r e is n o re a l d is c r im in a tio n in th is
c a s e : th e t a x b u r d e n is b o r n e a c c o r d i n g to
th e a m o u n t o f c o a l c o n s u m e d a n d n o t
a c c o r d i n g t o an y d is tin c tio n b e tw e e n in ­
s ta te an d o u t-o f -s ta te c o n s u m e r s .16

Some legal scholars maintain that Congress may
regulate state tax behavior through its authority
to regulate interstate commerce in the national
interest. In response to tax rate hikes on coal by
the states of Montana and Wyoming from 1975
to 1977, the House Interstate and Foreign Com­
merce Committee reported out a bill, though it
was not voted on by the lull House, that would
limit state severance taxes on coal to 12.5 per­
cent of value.1
Although this type of legislative action would
ultimately be challenged under the U.S. Consti­
tution, it presents a method for consuming states
to limit the perceived fiscal windfalls accruing to
energy7 state governments. Even if such a law
withstood judicial challenge, however, energy-

Commonwealth Edison Co. et al. State o f Montana,

615 p. 2d 847, 855 (1 9 8 0 ). The Montana tax was also
challenged under the supremacy clause of the Constitution,
Article VI Section 2.

^Commonwealth Edison Co. etal. v. State o f Montana,
(pp. 2954-2955).
17H. R. 6625, 96th Congress. This bill would have only
affected Montana and Wyoming.


producing states could conceivably replace fore­
gone severance tax revenues by such methods as
restructuring or instituting corporate income
and statewide taxes on energy production.1
Rising world energy prices in recent years
have sharply increased state tax revenues from
energy production in several western and south
central states. These revenues have caused con­
cern among energy-consuming states that view
these revenues as significant regional income
transfers at their expense. Producing-states
spokesmen have responded that taxes levied on
energy production compensate their residents
for the increased public service costs of hosting
energy industries, for environmental damage to
undeveloped plains and coastlines, and for the
loss of treasured lifestyle that accom panies
energy-related in-migration of population.
While the actual extent of regional income
18For example, Texas and Wyoming currently impose no
state corporate income tax.


transfer will continue to be scrutinized, some
consuming states have acted on the basis of real
or perceived income losses by revising their own
state tax structures to capture energy company
profits. Methods include challenging the legality
of state severance taxes and supporting Con­
gressional initiatives to limit state severance tax­
ation. Although none of these measures can
claim great success to date, the possibilities for
Congressional limitation on energy state sever­
ance taxation have not yet been exhausted.
However, even in the event that a bill to limit
severance taxation was committed into law, its
success in restraining inter regional income
transfers would be questionable. Energy-pro­
ducing states possess alternative tax vehicles,
such as corporate income taxes, gross receipt
taxes, as well as state and local property taxes,
that can be imposed with much the same effect
on tax reporting as severance taxation. Moreover,
a national concern arises over this potential
seizure of state government tax domain. Regional
retaliation through further Congressional action
might destabilize state fiscal systems.

Economic Perspectives

B a n k e rs d isa g re e o n p ath
to in te rs ta te b an k in g
The fences that protect state banking markets
from out-of-state intruders are collapsing. To a
limited extent, interstate banking already exists
in the United States through various ad hoc
means and is becoming more widespread every
day. To many people, the issue, therefore, is no
longer whether interstate banking should be
permitted but rather how interstate banking
should be formalized. This issue was at the cen­
ter of a discussion on interstate banking at the
Federal Reserve Bank of Chicago’s twentieth
annual conference on Bank Structure and Com­
petition, held April 23-25, 1984 in Chicago.
A panel of four distinguished bankers gave
their views and perspectives on interstate bank­
ing. The panel included Thomas C. Theobald,
vice chairman of Citicorp/Citibank; Thomas I.
Storrs, retired chairman of NCNB Corporation of
North Carolina; George Phalen, vice chairman of
Bank of Boston; and Gerald T. Mulligan, vice
chairman of Mutual Bank in Boston.
Larry Frieder, an associate professor of
banking at Florida A&M University, moderated
the interstate banking panel. In establishing a
framework for the discussion, Frieder empha­
sized that the public interest should be para­
mount in all modifications of the financial struc­
ture and that, although a large number of
interstate banking alternatives exist, what eco­
nomic theory dictates as optimal may not be in
the realm of political possibility. He also noted
that the role that the federal government will
choose to take in interstate banking is still
The reality o f interstate banking
The panel acknowledged that even though
the McFadden Act and the Douglas Amendment
to the Bank Holding Company Act remain intact,
de facto interstate banking exists. For example,
when interstate banking was outlawed, “
fathering” allowed banking companies that al­
ready owned banks in more than one state to

Federal Reserve Bank o f Chicago

retain those institutions, in some circumstances.
Such grandfather provisions permitted 12 bank
holding companies to own a total of 130 out-ofstate banks.
The Bank Holding Company Act itself, iron­
ically, is another path that leads to de facto inter­
state banking. Section 4 c ( 8 ) of the act allows
bank holding companies to operate nonbank
subsidiaries on an interstate basis. These sub­
sidiaries offer such services as consumer and
commercial lending, leasing, data processing,
financial advice, management consulting, and
credit life insurance. As of March 1983, a total of
139 bank holding companies operated 382 non­
bank subsidiaries with over 5,500 offices in
states other than their parents’ home states. The
Douglas Amendment to the Bank Holding Com­
pany Act allows bank holding companies to
acquire banks across state lines if such an acqui­
sition is permitted by the target bank’s state. As
of June 1 , 1 9 8 4 , 1 9 states had passed some sort of
interstate banking legislation. Also, the same
loophole in the Bank Holding Company Act that
gave rise to the ‘‘nonbank bank” allowed further
crumbling of the barriers to interstate banking in
March 1984 when the Federal Reserve Board
approved U.S. Trust Corporation’s application to
convert its Florida trust company into an institu­
tion that accepts consumer deposits and makes
consumer loans. According to the B an kin g
E xp an sion R ep orter as of April 1984, 30 bank
holding companies have applied to establish
nearly 200 limited service banks that either do
not make commercial loans or do not accept
demand deposits.
The Gam-St Germain Depository Institu­
tions Act of 1982 provides yet another route to
interstate banking. An emergency provision of
this law allows banks and S&Ls to acquire failing
institutions across state lines under certain cir­
cumstances. Since the act was passed, Citicorp
alone has acquired three failing S&Ls in as many
states—California, Illinois, and Florida.


Regional com p acts
One popular approach to formalizing the
interstate banking movement is through regional
compacts. A regional compact is a regional re­
ciprocity agreement whereby individual states
within a well-defined region pass legislation that
allows banking firms within the region to merge
with or acquire other banks within the region.
New England is currently experimenting with a
regional compact, as is the Southeast. New En­
gland’s compact encompasses 6 states, and the
Southeast’s compact includes 12 states and the
District of Columbia (although only a few of the
southeastern states have ratified the compact so
far). Such arrangements are also being consid­
ered in other parts of the country.
Each panelist at this year’s Bank Structure
Conference commented on this approach, but
perhaps its most ardent supporter was Thomas I.
Storrs, retired chairman of NCNB Corporation of
North Carolina.
Storrs bases his support for regional bank­
ing on two considerations. First, despite what
many analyses on the subject indicate, large size
d o es provide advantages in banking. And second,
bankers do attempt to increase size, market
share, and profitability through mergers. Conse­
quently, according to Storrs, full nationwide
banking, if permitted, would result in a banking
system similar to those of England and Canada,
where a few large banks hold almost all of the
domestic deposits. Such a system is completely
unacceptable to Storrs, who points to the prob­
lems caused by oligopolistic structures in the
auto and steel industries.
Some, however, have argued that large
banks will be necessary to compete with such
nonbank competitors as Sears and Merrill Lynch.
Storrs does not buy this notion. “We may need to
even up the odds a bit,” said Storrs, “but there’s
no point in setting the fox to guard the hen
house.” The best way to even up the odds,
according to Storrs, would be through a banking
system that ensures that no single bank has a
monopoly in any single market.
Pointing to the market structure that has
evolved in North Carolina, he said that regional
banking “would permit regional banks to emerge


as stronger and thus more competitive forces in
markets where they meet the money center
banks,” and it would allow banks to achieve the
size that is so important in competing with non­
banks. Furthermore, regional banking would
lead to a banking market with a large number of
effective competitors—“too many for the impedi­
ments to competition that sometimes character­
ize oligopoly.”
Two others on the interstate banking panel
also favor regional interstate banking. George
Phalen, vice chairman of Bank of Boston, prefers
the regional interstate banking approach because
of its political feasibility. “Congress finds it
exceedingly tedious to deal with controversy in
banking powers,” said Phalen, but regional com ­
pacts may make it easier for Congress to address
the issue of “ocean-to-ocean” banking. And if
Congress fails to deal with the issue, then the
state laws could be amended to encompass
broader geographic areas.
Phalen also pointed out that regional bank­
ing is a more “comfortable” approach to inter­
state banking. In New England, for example,
Bank of Boston is familiar to New England resi­
dents. It understands the needs of the region and
provides services that other banks from outside
the region are less likely to offer.
Gerald T. Mulligan, vice chairman of Mutual
Bank of Boston and former Commissioner of
Banks for Massachusetts, was another panelist
who favors the regional approach. Mulligan
emphasized the importance of local orientation.
Commenting on the regional interstate banking
experience in Massachusetts, Mulligan said that
the Massachusetts legislature recognized the
inevitability of interstate banking and its atten­
dant loss of local control by Massachusetts insti­
tutions. Regional interstate banking was seen as a
means to allow Massachusetts institutions to
attain “sufficient size so as to ensure both con­
tinued relevance in the increasingly competitive
marketplace” and some measure of local orien­
tation. At the root of the legislature’s concern for
local interests, according to Mulligan, was “the
belief that there exists individualized local credit
needs that are best understood and met by
locally based financial institutions.” Mulligan
noted that New England bankers are much more

Economic Perspectives

adept at making fishing loans than are bankers
from Chicago, and that Chicago bankers are
much better at lending to farmers.
Regional banking: a first step
Regional banking is often viewed as a first
step toward lull nationwide banking. Both George
Phalen and Gerald Mulligan stated that regional
interstate banking could facilitate the move to
full nationwide banking. Mulligan drew a parallel
between New England’s NOW account experi­
ment and the New England Compact. In 1972
the NOW account was introduced in Massachu­
setts and subsequently spread throughout the
country. A decade later, Massachusetts initiated
the New England Compact on regional interstate
banking, and by 1984 similar regional compacts
were being considered in every part of the coun­
try. “What started as a regional experiment,” said
Mulligan, “may quickly becom e a nationally
accepted interstate banking pattern on the path
to full nationwide interstate banking.” If the
experiment fails, George Phalen added, “then
we will continue to follow the process of finding
loopholes and acquiring failing banks.”
Some states, including Rhode Island and
Kentucky, have included “trigger” provisions in
their interstate banking laws. Such a provision
removes all geographic barriers on a specified
date, opening the state’s doors to banking insti­
tutions from all parts of the country.
A study on interstate banking that modera­
tor Larry Frieder directed for the Florida legisla­
ture sheds some light on the potential benefits of
trigger provisions. Analysis of the roads to take in
relaxing geographic restrictions suggested that
nationwide reciprocity would produce the most
competitive environment in the long run, but in
the short run large money center banks could
gain control of local markets. The study con­
cluded that regional reciprocity with a trigger
would allow for any benefits that would “result
from the construction and preservation of large
regional banks” and ensure that “remaining geo­
graphical restrictions and any potential anti­
competitive effects of the eventual consolidation
and concentration of state and regional markets
would be addressed.”

Federal Reserve Bank o f Chicago

Thomas Storrs agreed that regional banking
could provide an effective transition to nation­
wide banking, but he voiced strong opposition
to trigger provisions. Storrs said that such provi­
sions only encourage bankers to look beyond the
trigger date to nationwide banking, thus defeat­
ing the whole transitional process. “If-and-whenagreements,” in which bank holding companies
agree to merge if and when the law allows, are
already in place. The main problem with trigger
provisions, according to Storrs, is that they spec­
ify a time frame. He would prefer that a transition
period be “defined not in terms of years before
you start, but in terms of achieving a level of
pro-competitive market structure that will en­
sure, for some time to come, a competitive
market among nationwide banks.”
Full nationw ide banking
One panelist who was not in favor of trigger
mechanisms or, for that matter, regional reci­
procity agreements was Thomas C. Theobald,
vice chairman of Citibank/Citicorp. Theobald
supports a national banking market, “or short of
that, reciprocal interstate banking, in which
individual states would throw their doors wide
open to banks from all states that return the
According to Theobald, better services and
lower prices for consumers will result from the
increased competition that would accompany
nationwide banking. Regional banking, however,
“has all the inherent deficiencies o f . . . single­
state banking. To redraw the boundaries of fifty
smaller markets into a half dozen larger but still
controlled markets is contradictory to the cause
of better service through competition.”
Theobald said that the local-interest con­
cerns of Storrs and Mulligan are unwarranted.
Citicorp, for instance, provides credit to cus­
tomers in all fifty states to meet local needs. He
added, “I can’t imagine the circumstances that
would cause us to alter our lending patterns if
we were given the power to take deposits
[across state lines]; the market for credit . . .
doesn’t depend on the deposit side.” Theobald
also suggested that concerns about large out­


side institutions gaining control of local institu­
tions could be addressed by requiring de novo
Since the Bank Structure Conference was
held, banks have continued to take whatever
road was open in order to offer financial services
across state lines, further trampling the geo­
graphic barriers in their way. Three more states
in the Southeast passed regional reciprocal legis­
lation. Sun Banks Inc., Florida, and Trust Com­
pany of Georgia agreed to merge. In New En­

gland, Bank of Boston Corp. gained approval
from the Federal Reserve Board to acquire
Colonial Bancorp of Waterbury, Connecticut.
And Citicorp won Federal Reserve Board approv­
al to establish a bank in Maryland. Indeed, unless
Congress acts, the methods for achieving inter­
state banking will probably continue to be quite
diverse. Yet whatever path is taken, the end is
generally the same: a more competitive market
for financial services.
—Christine Pavel

Next year's Bank Structure Conference will be
held May 1-3, 1985 in Chicago. If you would like to be
added to the mailing list for the Conference, send your
name and address to the attention of Alice Moehle:
Federal Reserve Bank of Chicago
P.O. Box 834
Chicago, Illinois 60690-0834


Economic Perspectives

E c o n o m ic re c o v e ry a n d jo b s
in th e S ev en th D istrict
Jerry S zatan a n d W illiam A. Testa
The states of the Seventh Federal Reserve Dis­
trict (Illinois, Indiana, Iowa, Michigan, and Wis­
consin) suffered employment losses of over five
percent (6 8 3 ,0 0 0 jobs) during the economic
downturn of 1981-82. This compares with a
three percent national decline. During the short
but sharp recession of 1980, District states’
employment fell by three and one-half percent
compared with one percent nationally. Between
these recessions the 1980-81 national recovery
never materialized in the Seventh District; Indi­
ana alone recorded an employment increase
during this period. The Seventh District endured,
in effect, a single long and deep recession over
the years 1980 to 1982.
The United States is now enjoying rapid
econom ic growth, with gross national product
(G N P) increasing at above average rates for this
stage of a recovery, and falling unemployment
rates. Due to the severity of the economic
decline in the Seventh District, the extent to
which the District shares in this national recov­
ery is critical in assessing the prospects for re­
employing the District’s labor force. This article
provides a perspective on this issue by examin­
ing employment changes in the Seventh District
from 1969 to the present against the backdrop of
national econom ic trends. The current expan­
sion in the District states is described and com ­
pared to historical national and regional upturns
to aid in assessing the outlook for job growth in
the months and years ahead.
Em ploym ent grow th 1969 to 1984
Although the roots of Midwestern economic
decline can be traced prior to the 1970s, job
growth in the older industrial heartland has only
markedly lagged the nation over the last ten *
William A. Testa and Jerry Szatan are regional econo­
mists at the Federal Reserve Bank of Chicago. They thank
Steven Langford for research assistance.

Federal Reserve Bank o f Chicago

years. During the national wartime economy of
the 1960s, rapid econom ic expansion masked a
long-term decline in many older manufacturing
areas, including several Seventh District states.
Subsequently, slower national growth and increas­
ing foreign competition in manufacturing reveal­
ed the long-running erosion in many basic
midwestern industries. Only a surge in farm
income can be identified as a significant counter­
vailing trend to midwestern decline in the
From the fourth quarter of 1969, the peak of
the 1960s expansion, to the second quarter of
1984, employment in the nation grew approxi­
mately 32 percent, compared with less than 9
percent in the Seventh District (Table 1). Much
of this relative decline reflects the sagging state
of basic manufacturing industries nationwide
(Table 2). Because manufacturing comprises a
greater share of total non-agricultural employ­
ment in the District than in the United States
(2 5 .3 percent compared with 20.9 percent in
1984: II), the generally shared decline in manu­
facturing employment had a disproportionately
greater effect on total employment in the District.
District manufacturing employment also
lost ground relative to other regions of the Uni­
ted States, aggravating the area’s employment
decline. The percentage decrease in manufac­
turing employment in the Seventh District was
20 percent between 1969 and 1984, over seven
times greater than in the United States.
Although the overall story of Seventh Dis­
trict employment is one of relative decline, there
are notable differences among the states. Job
expansion in both Iowa and Wisconsin substan­
tially exceeded Illinois, Indiana, and Michigan
over the 1969-1984 period (Figure 1). Total
’Average yearly total net farm income in the U.S.
increased nearly a quarter from the 1960s to the 1970s. To
date, income in each year of the 1980s has fallen far short of
the 1970s average.


Table 1
P e rc e n t c h a n g e in to ta l n o n ag ric u ltu ra l e m p lo y m e n t in th e U .S . and S e v e n th D is tric t s ta te s —
fo u rth q u a rte r o f 1 9 6 9 to th e secon d q u a rte r of 1 9 8 4 (se a s o n a lly a d ju s te d )
4th quarter 1969 to
1st quarter 1980

1st quarter 1980 to
4th quarter 1982

4th quarter 1982 to
2nd quarter 1984

4th quarter 1969 to
2nd quarter 1984

(percent change)

(percent change)

(percent change)

(percent change)


- 8.4
- 8.4
- 9.3
- 6.8
- 9.2
- 2.4



7th District states
United States

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Employment and Earnings.

T ab le 2
P e rc e n t ch a n g e in m a n u fa c tu rin g e m p lo y m e n t in th e U .S . and S e v e n th D is tric t s ta te s —
fo u rth q u a rte r of 1 9 6 9 to th e secon d q u a rte r of 1 9 8 4 (seaso nally a d ju s te d )
4th quarter 1969 to
1st quarter 1980

1st quarter 1980 to
4th quarter 1982

4th quarter 1982 to
2nd quarter 1984

4th quarter 1969 to
2nd quarter 1984

(percent change)

(percent change)

(percent change)

(percent change)

- 7.9
- 9.3
- 5.0



- 7.1
- 2.7
- 2.7

7th District states
United States

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Employment and Earnings.

employment increased by over 17 percent in
Iowa and by over 23 percent in Wisconsin com ­
pared with the District average of 8.6 percent. In
fact, below-average employment growth in Iowa
and Wisconsin, relative to the United States,
dates only from the first quarter of 1980. Until
then, employment growth in these states had
matched or exceeded the national rate.2
Manufacturing employment in District states
exhibits a similar pattern. Manufacturing jobs
over the 1969-1984 period decreased much less
in Iowa and Wisconsin than in the remaining
District states ( Figure 2 ). Once again, Iowa’s and
Wisconsin’s trouble dates from the first quarter
of 1980. Between 1969 and 1980, manufactur­
ing employment grew more in Iowa and Wis­
2One factor in this favorable performance was the
strength of the farm economy during the 1970s. Industries
such as food processing and farm equipment are important
sectors of Iowa’s and Wisconsin’s economies.


consin than in the United States. In sharp con­
trast, manufacturing employment declined in
the District states of Michigan, Illinois, and
Indiana from 1969 onward, increasingly falling
behind manufacturing employment in the United
Em ploym ent change and th e business cycle:
1969 to 1984
Another perspective on the Seventh Dis­
trict’s relative long-term employment decline is
provided by examining its percentage change in
employment relative to the nation in periods of
national expansion and contraction. Total employ­
ment losses have been greater in the District
than in the United States during every recession
between 1969 and 1984 (Table 3). This has also
been true for every state in the District in every
recession, except for Iowa in 1969-70 and Iowa

Economic Perspectives

The economies of the states that make up the
Seventh Federal Reserve District are in transition.
Once proudly referred to as the “industrial heart­
land” of America, these states have more recently
been characterized as the nation’s “Rust Belt.”
Now after a sustained period of economic adversity
within the region, efforts are underway within the
District to devise policies to halt or reverse what is
perceived to be an unacceptable course of eco­
nomic events—the continued relative decline of
the Midwest economy.
Public and private sector studies dealing with
Midwestern economic troubles have largely focus­
ed upon describing and understanding the nature
and causes of economic change within the region.
The studies frequently cite the following prob­
lems: high wages, declines in productivity, union­
ization, foreign competition, high energy prices,
low levels of federal spending, and weaknesses in
the farm economy. Based on these findings, eco­
nomic development groups on both state and local
levels are beginning to formulate programs and
policies intended to bring about a revitalization in
state and local economies.
The Federal Reserve Bank of Chicago has
intensified its own involvement in regional eco­
nomic programs. For example, the Chicago Fed has
been playing an active role in two economic devel­
opment projects within the District—the Com­
mercial Club of Chicago’s study of the Chicago
metropolitan economy and the Wisconsin Stra­
tegic Development Commission’s study of the
Wisconsin state economy. The role of the Chicago
Fed has been primarily directed toward the devel­
opment of a regional economic data base to sup­
port these efforts and the analysis of data to aid
decisionmakers in their policy formulation.

and Wisconsin in 1973-75.
A greater-than-national drop in employment
during a recession will not result in a region’s
long-term decline if cyclical downturns are
offset by greater-than-national employment gains
during expansions. Unfortunately, this has not
been the case in the District in recent years.
During the expansion of 1970-73 employment
growth in every District state except Illinois
exceeded the nation. But in the recovery period

Federal Reserve Bank o f Chicago

While reflecting a higher degree of concern
and interest in regional economic development
than in previous years, such a focus is in no way
new, for the Federal Reserve System from its incep­
tion in 1913 was established as a regionally decen­
tralized institution. Because of this regional struc­
ture, individual Reserve Banks are in a unique
position to monitor and evaluate regional eco­
nomic developments. Because they often help to
spot early developments not yet reflected in statis­
tical series at the national level, summaries by the
Reserve Banks of regional economic conditions
and trends have historically proved to be useful in
interpreting overall economic trends and are used
in the System’s process of formulating monetary
policy. In addition, reports by Reserve Bank presi­
dents reflect a special knowledge about banking
and economic conditions within the region.
Regional economic development efforts raise
a number of interesting and important issues con­
cerning the impact and appropriateness of sub­
national economic development efforts. Debates
over such topics are nothing new; examples may
be found early in America’s economic history. In
the Jefferson administration in the early 1800s, the
Secretary of the Treasury issued a “Report on Pub­
lic Roads and Canals” that was intended as a
national plan for integrating the far-flung regions of
a then young nation. This plan generated extensive
and continuing debate about the overall merits of
planning, and disagreements as to national versus
sub-national economic development planning. In
future issues of Economic Perspectives and else­
where, Chicago Fed researchers will deal in more
detail with such policy topics and related issues
relevant to economic trends and developments in
the Seventh District.

from 1975 to 1980, employment grew less in
every District state than in the nation, although
Wisconsin almost equaled the national rate.
This poor performance worsened in the
early 1980s. During the short-lived national re­
covery of 1980-81, not only did the rate of
national employment gain exceed the rate in
every District state, but every state except Indi­
ana actually co n tin u ed to lo se employment.
For the most part, first quarter 1980 through


Figure 1

Index of quarterly employment in the U.S. and Seventh District States
index (1969 Q 4 = 100)

Econom ic reco v ery 1982-1984

However, among Seventh District states, only
Michigan’s employment recovery coincided with
the nation’s recovery with every other state lag­
ging the national recovery (Figure 3 ) 3 Employ­
ment continued its slide for two quarters into
the national recovery in Indiana and Iowa and
three quarters in Illinois.
Districtwide employment is now up 2.5
percent after six quarters of recovery but this is
less than one-half the national growth for the
same period. Among District states, only Michi­
gan’s employment gain of 5.1 percent approaches
the nation’s gain of 5.7 percent. Employment

Beginning in the fourth quarter of 1982,
economic recovery began to pull national employ­
ment out of its slide. By the second quarter of
1984, employment in the United States stood 5.7
percent above its level at the recession’s trough.

}The state and U.S. mean historical employment indices
were constructed by averaging the individual index levels
over the 1970-73,1975-80, and 1980-81 national recoveries.
Note that the 1980-81 recovery was truncated after 4 quar­
ters so that, beyond this point, the mean historical recovery
represents averages of the 1970-73 and the 1975-80 recov­

fourth quarter 1982 comprised a single long,
deep recession in the District. Jo b losses in Sev­
enth District states ranged from 6.8 percent in
Wisconsin to 11.9 percent in Michigan, while
employment in the nation declined by only 2.4
percent. By November of 1982, the recession’s
trough, unemployment measured 13 percent in
the District compared with 10.4 percent in the
United States. State unemployment rates in the
District ranged from 8.5 percent in Iowa to 16.4
percent in Michigan —the highest in the nation.


Economic Perspectives

Figure 2

Index of quarterly manufacturing employment in the U.S. and Seventh District states
index (1969 Q 4 = 100)

T ab le 3
P e rc e n ta g e c han ge in total e m p lo y m e n t during n ation al cyclic a l sw in g s —
S e v e n th D is tric t sta te s , 1 9 6 9 - 1 9 8 4 (se a s o n a lly a d ju s te d )




1969: 4th quarter to
1970: 4th quarter

1970: 4th quarter to
1973: 4th quarter

1973: 4th quarter to
1975: 1st quarter

1975: 1st quarter to
1980: 1st quarter

- .8
- .7


- .4


7th District states





1980: 1st quarter to
1980: 3rd quarter

1980: 3rd quarter to
1981: 3rd quarter

1981: 3rd quarter to
1982: 4th quarter

1982: 4th quarter to
1984: 2nd quarter


- .5
- .4
- .7



7th District states

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics, Employment and Earnings.

Federal Reserve Bank o f Chicago


Figure 3
Total employment: Recovery patterns in the Seventh District states
and the U.S. Historical recovery (1970, 1975, 1980*) vs. current recovery





Index: Employment in each trough = 100.
‘ Recovery from 1980 trough lasted four quarters. Mean after four quarters does not include post-1980.


Economic Perspectives

growth in Iowa and Illinois, .2 percent and 1
percent, respectively, has been especially weak.
Because current employment growth in
most District states has been slower than the
national rate and because employment loss was
more pronounced in the Midwest from 1980 to
1982, expansion time needed to regain previous
levels of District employment will be greater
than in the past. By the fourth quarter of 1983,
the national economy had surpassed its previous
employment peak (9 1 .4 million jobs), which it
had reached during the third quarter of 1981. In
contrast, if the Seventh District employment
growth continues at the average quarterly pace
of the fourth quarter 1982 to second quarter
1984, the third quarter 1981 employment level
will not be regained until after the first quarter of
1986. The level of employment recorded in the
first quarter of 1980, 13-78 million jobs, would
not be reached until the end of 1988.
Despite the weak rates of employment
growth during the current recovery, the histor­
ical pattern of economic recovery and expansion
in the region suggests that continued national
recovery will accelerate the pace of District
employment growth relative to the U.S.4 With
the exception of Illinois, the average employ­
4Of course, no two recoveries can be expected to be
identical because many other conditions such as trade poli­
cies, secular industry trends and government support pro­
grams greatly differ from time to time. Still, national cyclical
behavior and its regional components display some fairly
consistent behavior. For example, capital goods industries
tend to “kick in” to national recovery after the first year as
manufacturing firms begin to invest in plant and equipment.
This has accounted for late-recovery employment accelera­
tion in states with large capital goods industries such as

Federal Reserve Bank o f Chicago

ment growth rate in each District state over the
1970-73, 1975-80, and 1980-81 national expan­
sions reveals some modest gain on the national
rate of growth as expansion extends into the fifth
and sixth quarters and beyond (Figure 3)- While
it is unlikely that previous District employment
levels will be quickly regained due to this accel­
eration, the current rate of economic recovery
in the states of Indiana, Iowa, and Wisconsin
probably understates the near-term employ­
ment outlook.
Led by a faltering manufacturing sector, the
Seventh District economy has continued to
decline relative to the nation over the 1969-84
period. In recent years, weak employment growth
in the region during national economic expan­
sion gives evidence of an acceleration of regional
decline. Regional employment growth trailed
the nation during the 1975-80 expansion and it
continues to lag during the current recovery.
Meanwhile, recovery in this District never mate­
rialized during the short-lived national recovery
in 1981-1982 so that District employment de­
clines from 1980 to 1982 are staggering. A con­
tinuation of econom ic expansion in the District
at the current pace would not regain these jobs
until 1988. The econom ies of every District
state, except Illinois, have displayed a modest
historical tendency to accelerate relative to the
nation as the expansion extends into the second
year. However, the District’s employment growth
rate would have to substantially exceed the
national rate if job losses of the early 1980s are to
be recouped in the near future.


Did u su ry ce ilin g s
h o ld d o w n au to sales?
D on n a C. V an den brin k
Usury ceilings have been implicated, along with
persistently high interest rates, as culprits in the
long, deep slump in the automobile sector that
occurred in the late 1970s and early 1980s. As
the prime rate rose from the 6-8 percent range of
1977 to 20 percent in 1981, lenders in many
states were restricted from charging higher rates
for automobile financing by long-standing usury
ceilings. Over the same period retail sales of
passenger cars fell from over 11 million in 1977
and 1978 to 8.5 million in 1981. Looking over
this situation, a representative of the National
Automobile Dealers’ Association testified in Con­
gress in 1980 that state usury limits were contrib­
uting to the econom ic decline of the motor
vehicle industry.1 He argued that these ceilings
caused a significant reduction in banks’ automo­
bile lending, which in turn curbed consumer
demand for automobiles.
The purpose of this paper is to investigate
the effect of usury' ceilings on the retail sales of
automobiles. Both the conventional treatment of
usury ceilings by econom ic theory and previous
empirical research suggest that usury ceilings on
automobile finance rates would be detrimental
to automobile sales in periods of high interest
rates. However, a statistical analysis of automo­
bile sales in Illinois and Michigan between 1977
and 1982 did not discern any clear effect of
binding ceilings. I attribute the failure of the data
to support this hypothesis to the peculiar cir­
cumstances of automobile financing.
Donna Vandenbrink is an economist at the Federal
Reserve Bank of Chicago.
'“State Usury Ceilings and Their Impact on Small Busi­
ness,” Hearings before the House Committee on Small Busi­
ness 96 Cong. 2 Sess. ( Government Printing Office, 1980 ), p.
101. See also, Charles J. Elia, “Rising Prime Rate Plus States’
Usury Ceilings Put a Kink in Car Industry’s Recovery Out­
December 3, 1980.

Wall Street Journal


According to the standard theoretical anal­
ysis, when lenders are prevented by usury ceil­
ings from raising finance rates to meet the added
costs of higher economy-wide interest rates,
they will respond by reducing the amount of
credit they are willing to lend and strengthening
noninterest credit terms.2 It stands to reason,
that when usury ceilings limit the supply of
credit, they will inhibit sales of credit-financed
Several empirical studies of the effect of
usury ceilings on the housing market support
this reasoning, linking the effect of usury ceilings
on credit supplies to their effect on consumer
purchases. These studies have documented a
connection between binding ceilings on mort­
gage rates and reduced new housing construc­
tion.' With the recognition that half or more of
all new car purchases are financed by credit, the
automobile market appears to present a situa­
tion similar to the housing market. We expect,
then, that usury' ceilings which restrict automo­
2See D. Vandenbrink, “The Effects of Usury' Ceilings,”

Economic Perspectives, (Midyear 1982), pp. 44-55.

'Studies of the effect of usury ceilings on the mortgage
market and homebuilding include: Ernest Kohn, Carmen J.
Carlo, and Bernard Kay,
New York State
Banking Department, January 1976; James E. McNulty, “A
Reexamination of the Problem of State Usury Ceilings: The
Impact on the Mortgage Markets,”
vol. 20 (Spring 1980), pp. 16-29; R
Ostas, “Effects of Usury Ceilings in the Mortgage Market,”
vol. 31 (June 1976), pp. 821-34; Dwight
Phaup and John Hinton, “The Distributional Effects of Usury
Laws: Some Empirical Evidence,”
vol. 9 ( Sept. 1981), pp. 91 -98; Phillip K. Robins, “The Effects
of State Usury Ceilings on Single Family Homebuilding,”
vol. 29 (March 1974), pp. 227-36;
Arthur J. Rolnick, Stanley Graham, and David S. Dahl, “Minne­
sota’s Usury Law: An Evaluation,”
vol. 11 (April 1975), pp. 16-25; and Steven M. Craffon, “An
Empirical Test of the Effect of Usury' Laws
vol. 23 (April 1980), pp. 135-146.

The Impact o f New York’s Usury
Ceiling on Local Mortgage Lending Actiiity,

nomics and Business,
Journal o f Finance,

Quarterly Review o f Eco­

Atlantic EconomicJournal

Journal o f Finance,

and Economics,

Ninth District Quarterly,
," Journal o f Law

Economic Perspectives

bile finance rates would also restrict sales of

'Among the numerous studies of automobile credit,
finance rates, and automobile demand, only a few have been
concerned specifically with the role of state rate ceilings, and
then they have focused only on their effect on automobile
credit markets, not on the market for automobiles. See R. P.
Shay, “The Impact of Legal Rate Ceilings on the Availability
and Price of Credit,” National Commission on Consumer
pp. 387-424; Douglas F. Greer
and Ernest A. Nagata, “An Econometric Analysis of the New
Automobile Credit Market,” National Commission on Con­
sumer Finance,
Richard L. Peterson and
Michael D. Ginsberg, “Determinants of Commercial Bank
Automobile Loan
, Spring
1981, pp. 46-55; and Daniel J. Villegas, “An Analysis of the
Impact of Interest Rate Ceilings,”
, Sep­
tember 1982, p. 941.

According to our model, these state usury
ceilings are only expected to affect auto sales
when the ceilings are lower than the rate auto
lenders would have charged in the absence of
legal restriction. In order to judge when these
ceilings actually were binding in Illinois and
Michigan, then, it is necessary to determine the
unregulated, or market, rate on auto loans. But
where usury ceilings exist we may not be able to
observe this market rate directly.6 For the pur­
pose of this study, the market rate was repre­
sented by the average U.S. rate on new automo­
bile loans, a series published by the Federal
Reserve System based on loan rates reported by a
sample of commercial banks drawn from through­
out the United States. In a period of high interest
rates, this measure is likely to understate the
market rate since the reported rates would have
been influenced by ceiling limits.
Figures 1 and 2 compare this measure of the
market rate on automobile loans to the ceilings
in Illinois and Michigan, respectively. Twice
between 1977 and 1982 the market rate rose
above each state’s ceilings, making the ceilings
binding. In Illinois, the periods of binding ceil­
ings were from the last quarter of 1979 until
January 1980 when the ceiling was raised, and
from about June of 1981 until September, when
the ceiling was eliminated. The periods were
roughly the same in Michigan: from November
1979 until the ceiling was increased in April
1980, and from mid-1981 through the last
observation in August of 1982. Figure 3 shows
that during these periods the rates reported on
the Federal Reserve survey by banks in Illinois
and Michigan were indeed below the national
“market” rate.
The hypothesis that auto sales are lower
during times when ceilings are binding than
when they are not was tested in regressions on
quarterly automobile registrations in Illinois and

'Typical of consumer lending regulations in most states,
in Illinois and Michigan different laws applied to automobile
loans made by different types of lending institutions. For
example, in Illinois direct loans by commercial banks to
individuals for the purchase of automobiles were subject to
the state’s general consumer installment loan ceiling while
the lenders were subject to a specific statutory ceiling cover­
ing motor vehicle retail sales. From 1977 to 1981, the ceiling
under the Illinois Motor Vehicle Installment Sales Act was
higher than the ceiling applicable to banks.

6Actual automobile loan rates are not an accurate indi­
cator of the market rate in states where ceilings are in fact
binding, since the actual rates reflect the influence of the
ceiling. All empirical studies of the effect of usury' ceilings
must face this problem of how to measure the market rate of
interest. The preferred solution is to simulate a market rate
from observ ations of actual interest rates known not to have
been subject to a ceiling.

Usury ceilings and autom obile sales in
Illinois and Michigan
In this section we test this expectation
against actual experience with binding usury7
ceilings and automobile sales in Illinois and
Michigan. Mirroring the national decline in auto
sales, annual registrations of new passenger
automobiles in Illinois fell from 706,000 in 1977
to 454,000 in 1981 and in Michigan they dropped
from 6 6 4 ,0 0 0 to 4 4 6 ,0 0 0 over these same years.During much of this period, both states had legal
ceilings covering finance rates on automobile
loans. For the purpose of this study the ceiling on
automobile credit was defined as the maximum
rate permitted on direct automobile loans by
commercial banks.s In Illinois, that ceiling was
12.75 percent ( 7 percent add-on) until January7
1, 1980 when it was raised to 16.25 percent (9
percent add-on). Then, effective September 15,
1981, all Illinois ceilings on consumer loans
were eliminated. Michigan, on the other hand,
still has a ceiling of 16.5 percent, raised from
12.83 percent ( 7 percent add-on) on April 7,

Technical Studies IV,

Technical Studies IV;

Rates" Journal o f Bank Research
Journal o f Finance

Federal Reserve Bank o f Chicago


Figure 1

Illinois installment loan ceiling vs. U.S.
average bank rate on direct auto loans

mobile credit rates in these two states. For this
reason, an alternative dummy was constructed
based on a more liberal definition of “binding.”
This variable took the value 1 whenever the
“market rate” was above or less than 1 percent­
age point below the state ceilings. (This o c­
curred in 16 of the 44 observations.)

Figure 3

Most common rate on direct new auto
loans at commercial banks

NOTE: Shaded areas are periods when ceilings were binding.

Figure 2

Michigan motor vehicle loan ceiling vs. U.S.
average bank rate on direct auto loans


Michigan from 1977 through the second quarter
of 1982 (a span of 22 quarters). Three alterna­
tive variables were used to measure the effect of
the usury ceilings, two dummy variables and a
spread variable. One dummy variable was con­
structed to equal to 1 whenever the state ceiling
was below the U.S. average rate on bank auto
loans. (This occurred in 8 out of the 44 observa­
tions.) However, since our measure of the
market rate may understate the true market rate,
this dummy variable may not capture all the
times when ceilings were in fact binding auto­








The spread variable was devised to measure
the effect of the “bindingness” of the ceiling.
This variable was given a value equal to the
spread between ceiling and market rates when­
ever the two were closer than one percentage
point in absolute value. Otherwise it was set
equal to 1. In other words, the spread variable
ranged between -1 and 1, with a larger ( i.e., more
positive) value signifying a less binding ceiling.
Hence, the coefficient on this variable was
expected to be positive.
All regressions also included three variables
to control for other economic influences on
automobile sales: the state unemployment rate,
the quarterly change in state per capita dispos­
able income, and the prime rate. A higher unem­
ployment rate was expected to be associated
with a lower level of auto sales, while positive
changes in disposable income were expected to
bring about higher automobile sales. The prime
rate was intended to measure the influence of
interest rates on credit-financed purchases. In­

Economic Perspectives

eluding this variable was necessary to ensure
that the coefficien ts on the ceiling variables did
not also reflect the effect of the high interest
rates that caused the ceilings to become binding.
A final consideration in the specification
and estimation of the regressions was necessary
because the data from both states were pooled. A
dummy variable was included to measure any
difference in the average level of automobile
sales, other things equal, between the two state
cross-sections. This variable took the value of 1
for Illinois observations. In addition, the regres­
sions were estimated using the Parks technique
to take account of possible interdependence
between the cross-sections or autoregression in
the time-series.
The regression results are shown in Table 1.
In the first column, the effect of the ceiling is
measured by the simple dummy variable; the
second column uses the less restrictive defini­
tion to designate periods of binding ceilings; and

in the third column the spread variable replaces
the ceiling dummy. Overall the equations did
fairly well. The untransformed OLS regressions
explained over seventy percent of the variance in
automobile sales and the F-statistics in each
regression were significant. Higher unemploy­
ment rates had a negative effect on automobile
sales and, according to the Illinois dummy vari­
able, Illinois sold about 5.5 fewer automobiles
per 1000 population than Michigan. Higher
interest rates had the anticipated negative effect
on the level of automobile sales.
The results for the usury ceiling variables
are disappointing. Although all the coefficients
did have the expected signs, suggesting a nega­
tive relationship between binding ceilings and
automobile sales, none was statistically signifi­
cant. In other words, this negative pattern could
be attributed to chance as easily as to a system­
atic relationship. Thus, the experiences in Illi­
nois and Michigan do not strongly support the
claim that binding usury ceilings are detrimental
to automobile sales.

T a b le 1

A m odel fo r th e autom obile secto r
Im p a c t of usu ry ceilin gs on au to m o b ile sales
in Illino is and M ich ig a n : 1977-1 to 1982-11







State unemployment rate

-0 .77a


-0 .77a




Illinois dummy

-4 .75a


-4 .7 3 a

Ceiling dummy


Change in disposable

Alternate ceiling dummy


Spread variable
U.S. average prime rate




Summary statistics for untransformed OLS regression:







NOTES: Regressions estimated by Parks technique, a two-stage
procedure to correct for hetroskedasticity, contemporaneous correlation,
and auto-regression in the error structure of pooled time-series crosssection data. T-statistics are in parentheses.
S ignifican t at 5% level (one-tailed).

Federal Reserve Bank o f Chicago

One place to look for an explanation of why
the empirical results did not give stronger sup­
port to our expectations about the effect of
usury ceilings on automobile sales is in the way
automobile financing and sales differ from the
situation posed by either the standard theoreti­
cal analysis or the empirical studies of the hous­
ing sector. This section argues that when the
particular structure of the automobile credit
market is taken into account, it might not be
reasonable to expect that binding usury ceilings
will necessarily adversely affect the overall level
of automobile sales, after all.
Implicit in the model from which our initial
expectation was derived is the assumption that
consumers obtain credit independently of their
purchase of goods. The discussion below indi­
cates that this assumption is not appropriate to
the situation with automobile purchases. Accord­
ing to Table 2, at the end of December 1981,
commercial banks were the single largest source
of automobile credit holding 47 percent of the
S I 26 billion total automobile credit liability of


T a b le 2
A u to m o b ile c re d it o u tstan d in g by h o ld er
D ecem b er 1981
$ Billions


Commercial Banks



Finance Companies



Credit Unions






SOURCE: Board of Governors Federal Reserve System of Research
and Statistics. March 1982.

U.S. consumers. Finance companies followed
with 35 percent of the total and credit unions
had the smallest share, only 17 percent. What is
not clear from this table is the fact that the
finance company category is comprised almost
entirely of the finance subsidiaries of the major
automobile makers, the so-called “captive subs.”
Other consumer finance companies do virtually
no automobile financing.7 Table 2 also does not
make clear the role of automobile dealers in
supplying credit. Automobile dealers are the
initial credit contact for the majority of automo­
bile purchasers although they do not show up as
final holders of credit contracts. In most cases,
dealers conduct credit investigations and carry
out other credit-related tasks before placing
credit contracts with other financial institutions.
The amount of dealer-originated credit is size­
able. According to Table 2, of the $59 billion in
consumer automobile credit held by banks at the
end of 1981 almost sixty percent, $35.1 billion,
was indirect credit—credit which originated
with dealers. In addition, virtually all of the
automobile credit listed in the table under
finance company holdings was originated by

dealers. Thus, behind these data is the fact that a
significant portion of automobile financing is
arranged or provided by agents which have at
least some interest in the automobile sector.
Aggregate data on consumer automobile
credit suggest that these connections influence
the supply of automobile credit. As shown in
Figure 4 and Table 3, captive-sub finance com ­
panies behave differently than commercial banks
—lenders that are entirely independent of the
automobile sector. Figure 4 traces movements in
the prime rate and in automobile rates for com ­
mercial banks and finance companies from 1976
through 1982. Until early 1978 these three
interest rates stood in their typical relationships
with respect to one another: consumer automo­
bile loan rates were above the prime rate
(reflecting the higher administrative cost of
consumer over commercial lending) and finance
company rates were above rates at commercial
banks ( reflecting the higher risk clientele of the
finance companies).
These relationships changed considerably
after mid-1978. The prime rate rose from the 6-8
percent range of the early 1970s to 20 percent in
1981. Consumer automobile loan rates also
increased considerably during this period, but
not nearly as dramatically as the prime lending
rate ( due in part presumably to state usury ceil­
ings). What is most interesting is the change in

Figure 4

Auto loan interest rates fell below the prime
rate during recent recession years
annual percentage rate

’A staff member at the Board of Governors estimates that
the “captive subs” represent over 90 percent of the automo­
bile credit holdings attributed in the statistics to finance
companies generally. This is corroborated in a study by
Rosenblum and Siegel who estimated from company reports
that together GMAC, Ford Motor Credit, and Chrysler Credit
held $40.9 billion of the $45.2 billion figure (90.3% ) in the
finance company category of Table 2. This study also showed
that the holdings of three captive subs comprised one-third
of all outstanding automobile credit at the end of 1981.
Harvey Rosenblum and Diane Siegel,
Staff Study 83-1,
Federal Reserve Bank of Chicago.

Competition in FinancialSennces: The Impact o f Nonbank Entry,


Economic Perspectives

T ab le 3
Extensio ns of au to m o b ile credit:
M a r k e t s h a re and d ollar am o u n t 1 9 7 7 -1 9 8 1









share of market
Automobile credit
Commercial banks
Credit unions
Finance companies



Automobile credit
Commercial banks
Credit unions
Finance companies



$ billions

SOURCE: Board of Governors Federal Reserve System Division of Research and
Statistics, March 1982.

the relationship between the finance company
rate and the commercial bank rate. The gap
betw een the two closed in late 1979 and for
much of the time thereafter, bank rates topped
finance company rates. One interpretation of
this change is that it reflects an attempt by the
automakers to counter the threat of high interest
rates on sales by offering below-market finance
rates through their captive-subs.
Table 3, which shows the dollar amount of
automobile credit extended and market share by
type of lender for the years 1977 through 1981,
suggests that this strategy succeeded. According
to the upper panel of the table, finance company
credit extensions increased every' year from
1977 to 1981 while commercial bank exten­
sions rose moderately in 1978 and 1979 and
then dropped precipitously in 1980, coincident
with the surge in bank lending rates. The result
was a doubling of the finance company share of
the automobile credit market from 1977 to 1981
as shown in the lower panel of Table 3. Thus, it
appears below-market financing offered by the
captive-subs did retain some customers who
might have been discouraged from making auto­
mobile purchases because of the high cost of
bank financing.
We have seen that in the market for auto­
mobile financing, lenders are often connected to
the sellers of automobiles and that for these
lenders the credit business apparently was second­
ary to the business of selling automobiles during
a period of high interest rates and tight credit.

Federal Reserve Bank o f Chicago

Under this interpretation, automobile finance
companies becom e a source of automobile
credit that is insulated from the effect of usury
ceilings. Lenders who offer below-market rates
to maintain credit to support automobile pur­
chases would not be apt to restrict lending
because a usury ceiling prevented charging
higher rates. Lending by these finance compa­
nies would tend to offset the restrictive effect of
usury ceilings on credit supplied by independent
lenders, and the existence of such a ceilingneutral supply o f automobile credit would
weaken the aggregate connection between
binding ceilings and automobile sales levels.
C onclusion
Contrary to expectations, the empirical
investigation reported on in this paper did not
show that binding usury ceilings were a clear
factor in the decline in automobile sales in Illi­
nois and Michigan between 1977 and 1981. A
subsequent discussion looked to the distinctive
characteristics of the supply of automobile credit
to explain why the empirical work failed to sup­
port the original expectation. It was argued that
connections between automobile financing and
automobile retailing and the apparent willing­
ness of U.S. auto makers to subsidize credit
through their finance subsidiaries would tend to
make usury ceilings inoperative for a significant
portion of the supply of automobile credit. As a
result, binding ceilings on automobile finance


rates do not necessarily mean a reduction in total
automobile credit or, therefore, in aggregate
automobile sales.
This is not to say, however, that ceilings on
automobile finance rates are of no consequence.
For one thing, binding ceilings may still force
independent lenders like banks to restrict their
automobile lending. In addition, if they induce
automobile makers to offer greater credit subsi­


dies through their financing arms, the cost of this
subsidy is made up in other ways, perhaps in
higher automobile prices for all automobile pur­
chasers.8 It would be useful, therefore, for future
research to look at the effect of usury ceilings on
other aspects of the automobile market than the
number of autos sold.
8See “Low-interest loans: How the dealers do it,”
1982, p. 27.

ness Week, July 12,


Economic Perspectives

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