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Fiscal competition between decentralized jurisdictions, theoretical and empirical evidence

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  • Clément Carbonnier

    ()
    (THEMA - Université de Cergy-Pontoise, 33 boulevard du port, F 95011 Cergy-Pontoise cedex, France)

Abstract

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.

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Date of creation: 2008
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Handle: RePEc:ema:worpap:2008-17

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Keywords: Optimal taxation; Business taxes ; Tax competition ; Public capital; Firm location.;

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  1. Andrew F. Haughwout & Robert P. Inman & Steven Craig & Thomas Luce, 2003. "Local Revenue Hills: Evidence from Four U.S. Cities," NBER Working Papers 9686, National Bureau of Economic Research, Inc.
  2. Buettner, Thiess, 2003. "Tax base effects and fiscal externalities of local capital taxation: evidence from a panel of German jurisdictions," Journal of Urban Economics, Elsevier, vol. 54(1), pages 110-128, July.
  3. Büttner, Thiess, 1998. "Local Business Taxation and Competition for Capital: The Choice of the Tax Rate," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 98-43, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  4. 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.
  5. Mutti, John & Morgan, William & Partridge, Mark, 1989. "The incidence of regional taxes in a general equilibrium framework," Journal of Public Economics, Elsevier, Elsevier, vol. 39(1), pages 83-107, June.
  6. Barankay, Iwan & Lockwood, Ben, 2006. "Decentralization and the Productive Efficiency of Government: Evidence from Swiss Cantons," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5639, C.E.P.R. Discussion Papers.
  7. Masayoshi Hayashi & Robin Boadway, 2001. "An empirical analysis of intergovernmental tax interaction: the case of business income taxes in Canada," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 34(2), pages 481-503, May.
  8. Haughwout, Andrew F. & Inman, Robert P., 2001. "Fiscal policies in open cities with firms and households," Regional Science and Urban Economics, Elsevier, Elsevier, vol. 31(2-3), pages 147-180, April.
  9. Thornton, John, 2007. "Fiscal decentralization and economic growth reconsidered," Journal of Urban Economics, Elsevier, vol. 61(1), pages 64-70, January.
  10. Alesina, Alberto & Spolaore, Enrico, 1997. "On the Number and Size of Nations," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(4), pages 1027-56, November.
  11. Todd M. Gabe & Kathleen P. Bell, 2004. "Tradeoffs between Local Taxes and Government Spending as Determinants of Business Location," Journal of Regional Science, Wiley Blackwell, Wiley Blackwell, vol. 44(1), pages 21-41.
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