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Which Communities should be afraid of Mobility? The Effects of Agglomeration Economies on the Sensitivity of Firm Location to Local Taxes

  • Jordi Jofre-Monseny
  • Albert Solé-Ollé

This paper examines the effects of agglomeration economies (AE) on the sensitivity of firm location to tax differentials. An initial reading of the story suggests that, with AE, when a firm moves into a community attracted by a tax reduction, other firms may decide to move in as well. This suggests that AE increase the sensitivity of firm location to local taxes. However, a second version of the story reads that, if economic activities are highly concentrated in space, AE might offset any tax differential, hence suggesting a reduction in this sensitivity. This paper provides a theoretical model of intraregional firm location with Marshallian AE that is able to generate both hypotheses: AE increase (decrease) the effect of taxes when locations are (are not) of a similar size. We then use Spanish municipal data for the period 1995-2002 to test these hypotheses, analyzing the combined effect of local business taxes and Marshallian AE on the intraregional location of employment. In line with the theory, a municipality with stronger AE experiences lower (higher) tax effects if it is sufficiently dissimilar (similar) to its neighbors in terms of size.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2311.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2311
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