Taxable agglomeration rents across the Spanish local labour markets

This paper extends a linear footloose capital (FC) model to examine the effects of public spending allocations affecting firms’ relocation decisions on the link between agglomeration economies and business tax rates. We find that the standard results of taxable agglomeration rents in an FC model are either magnified or partially offset, depending on the relative intensities of these types of jurisdictions’ public spending allocations. Empirically, we aggregate data at the level of local labour markets (LLMs) to exploit the relationships from the model. LLMs data, as opposed to municipal-level data, allow, on the one hand, the fulfilment of the labour immobility assumption implied by FC models, and, on the other, the use of market potential as a meaningful proxy for agglomeration economies. The results of our estimations for the 447 Spanish LLMs over the period 2006–2016 find the existence of taxable agglomeration rents. Additionally, public spending allocations are found to have a significant impact on the agglomeration economies-tax-setting relationship. Our results are robust to controlling for alternative neighbourhood criteria.