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Fiscal Competition over Taxes and Public Inputs: Theory and Evidence

  • Sebastian Hauptmeier
  • Ferdinand Mittermaier
  • Johannes Rincke

We set up a model to characterize the reaction functions of governments competing for mobile capital by simultaneously setting both the business tax rate as well as the level of provision of a productive public input. Using a rich data set of local jurisdictions, we then test the predictions of the model with respect to the nature of strategic interaction among governments. Our findings from efficient estimation of a system of spatially interrelated equations for both policy instruments support the notion that local governments use both the business tax rate and public inputs to compete for capital. In particular, we find that if neighbors cut their tax rates, governments try to restore competitiveness by lowering their own tax and increasing spending on public inputs. If neighbors provide more infrastructure, governments react by increasing their own spending on public inputs.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2499.

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Date of creation: 2008
Date of revision:
Handle: RePEc:ces:ceswps:_2499
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  3. WILDASIN, David, . "Nash equilibria in models of fiscal competition," CORE Discussion Papers RP 804, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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  28. Kelejian, Harry H & Prucha, Ingmar R, 1999. "A Generalized Moments Estimator for the Autoregressive Parameter in a Spatial Model," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(2), pages 509-33, May.
  29. Wildasin, D.E., 1989. "Some Rudimentary Duopolity Theorem," Working Papers 9, John Deutsch Institute for the Study of Economic Policy.
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