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Tax Deductibility and Municipal Budget Structure

In: Fiscal Federalism: Quantitative Studies

  • Douglas Holtz-Eakin
  • Harvey S . Rosen

This paper investigates the effects of deductibility of local taxes on communities' budgetary decisions. Our focus is on how changes in the tax price of local spending induced by deductibility affect the mix between deductible and nondeductible revenue sources, and on expenditures. The econometric analysis is based on a rich data set that tracks the fiscal behavior of 172 local governments from 1978 to 1980. We find that the elasticity of deductible taxes with respect to the tax price is in the range -1.2 to -1.6; the tax price has no statistically significant effect on the use of nondeductible revenue sources; and the elasticity of local expenditures with respect to the tax price is about -1.8. Hence, if deductibility were eliminated, we would expect to see a substantial decline in local government spending.

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This chapter was published in:
  • Harvey S. Rosen, 1988. "Fiscal Federalism: Quantitative Studies," NBER Books, National Bureau of Economic Research, Inc, number rose88-1, August.
  • This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 7885.
    Handle: RePEc:nbr:nberch:7885
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. Feldstein, Martin S & Metcalf, Gilbert E, 1987. "The Effect of Federal Tax Deductibility on State and Local Taxes and Spending," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 710-36, August.
    2. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
    3. Daniel R. Feenberg & Harvey S. Rosen, 1985. "The Deductibility of State and Local Taxes: Impact Effects by State and Income Class," NBER Working Papers 1768, National Bureau of Economic Research, Inc.
    4. White, Halbert, 1982. "Instrumental Variables Regression with Independent Observations," Econometrica, Econometric Society, vol. 50(2), pages 483-99, March.
    5. Robert P. Inman, 1985. "Does Deductibility Influence Local Taxation?," NBER Working Papers 1714, National Bureau of Economic Research, Inc.
    6. Hettich, Walter & Winer, Stanley, 1984. "A positive model of tax structure," Journal of Public Economics, Elsevier, vol. 24(1), pages 67-87, June.
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