Political Incentives in Local Tax Setting: Evidence from the German Property Tax Reform

Local governments’ discretion over tax rates may be used strategically when politicians perceive that a tax burden falls differently across voter groups. We study this mechanism in the context of Germany’s property tax reform, which created exogenous variation in the tax across voter groups and municipalities by allowing states to adopt different property valuation models. Some federal states implicitly set a higher tax for rental properties than for comparable owner-occupied units. We show that, over an average post-announcement period of 3.6 years, municipal tax multipliers increased by 15 percentage points more when two conditions were met: municipalities were governed by homeowner-friendly parties and were located in states where tenants will face a higher tax base per square meter. By identifying political drivers behind sharp increases in German property tax multipliers in recent years, we provide causal evidence that higher-level governments’ tax-base choices change the electoral incentives governing local tax rates.