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The Incentive Effect of Fiscal Equalization Transfers on Tax Policy

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  • Thiess Buettner

Abstract

A theoretical analysis considers the impact of a typical system of redistributive “fiscal equalization” transfers on the taxing effort of local jurisdictions. More specifically, it shows that the marginal contribution rate, i.e. the rate at which an increase in the tax base reduces those transfers, might be positively associated with the local tax rate while the volume of grants received is likely to be inversely related to the tax base. These predictions are tested in an empirical analysis of the tax policy of German municipalities. In order to identify the incentive effect the analysis exploits discontinuities in the rules of the fiscal equalization system as well as policy changes. The empirical results support the existence of an incentive effect, suggesting that the high marginal contribution rates induce the municipalities to raise their business tax rates significantly.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1404.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1404

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Keywords: fiscal equalization; tax competition; fiscal federalism; incentive effect of taxation; regression discontinuity;

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References

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  2. Michael Smart, 1998. "Taxation and Deadweight Loss in a System of Intergovernmental Transfers," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 31(1), pages 189-206, February.
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  12. Christian Baretti & Bernd Huber & Karl Lichtblau, 2002. "A Tax on Tax Revenue: The Incentive Effects of Equalizing Transfers: Evidence from Germany," International Tax and Public Finance, Springer, Springer, vol. 9(6), pages 631-649, November.
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  15. Buettner, Thiess, 2001. "Fiscal externalities in local tax competition: empirical evidence from a panel of German jurisdictions," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 01-11, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  16. Baretti, Christian & Huber, Bernd & Lichtblau, Karl, 2002. "A Tax on Tax Revenue: The Incentive Effects of Equalizing Transfers: Evidence from Germany," Munich Reprints in Economics, University of Munich, Department of Economics 20129, University of Munich, Department of Economics.
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