This article provides theoretical and empirical evidence that local fiscal competition generates a bias toward low business tax rates. Furthermore, it is shown that this bias is stronger for smaller jurisdictions. First, a theoretical model is settled with private and public capital and a fixed factor. The fixed factor allows to consider differences between the jurisdictions. The results show that there exists a bias toward low tax rates due to tax competition. This bias generates an underprovision of public capital, and therefore production is smaller with tax competition than with cooperation. Moreover, the bias toward low tax rates is stronger for jurisdictions with less fixed factor. That means that tax competition generates a larger production decrease for smaller jurisdictions. The empirical part aims at estimating the bias toward low tax rates and its dependency with respect to the fixed factor. Panel regressions with temporal and individual fixed effects of the tax rates are implemented with French local data, using the creation of intercity communities. The results indicate that the bias toward low local tax rates is strong: up to 23% decrease for the smaller cities. It is also significantly decreasing with respect to the city size: there is no tax rate decrease due to tax competition for the biggest cities.
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Paper provided by THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise in its series THEMA Working Papers with number
2008-17.
Find related papers by JEL classification: H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects R12 - Urban, Rural, and Regional Economics - - General Regional Economics - - - Size and Spatial Distributions of Regional Economic Activity; Interregional Trade (economic geography) R30 - Urban, Rural, and Regional Economics - - Production Analysis and Firm Location - - - General
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