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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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  17. Agnès Bénassy-Quéré & Nicolas Gobalraja & Alain Trannoy, 2007. "Tax and public input competition," Economic Policy, CEPR;CES;MSH, vol. 22, pages 385-430, 04.
  18. Marko Köthenbürger, 2002. "Tax Competition and Fiscal Equalization," International Tax and Public Finance, Springer, vol. 9(4), pages 391-408, August.
  19. Buettner, Thiess, 2006. "The incentive effect of fiscal equalization transfers on tax policy," Journal of Public Economics, Elsevier, vol. 90(3), pages 477-497, February.
  20. Jack Mintz & Henry Tulkens, 1984. "Commodity Tax Competition Between Member States of a Federation," Working Papers 558, Queen's University, Department of Economics.
  21. Thiess Buettner, 1999. "Determinants of Tax Rates in Local Capital Income Taxation: A Theoretical Model and Evidence from Germany," CESifo Working Paper Series 194, CESifo Group Munich.
  22. 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.
  23. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
  24. Petchey, Jeffrey D. & Shapiro, Perry, 2009. "Equilibrium in fiscal competition games from the point of view of the dual," Regional Science and Urban Economics, Elsevier, vol. 39(1), pages 97-108, January.
  25. Matsumoto, Mutsumi, 2000. "A Tax Competition Analysis of Congestible Public Inputs," Journal of Urban Economics, Elsevier, vol. 48(2), pages 242-259, September.
  26. Taylor, Leon, 1992. "Infrastructural competition among jurisdictions," Journal of Public Economics, Elsevier, vol. 49(2), pages 241-259, November.
  27. Baicker, Katherine, 2005. "The spillover effects of state spending," Journal of Public Economics, Elsevier, vol. 89(2-3), pages 529-544, February.
  28. Bucovetsky, S., 2005. "Public input competition," Journal of Public Economics, Elsevier, vol. 89(9-10), pages 1763-1787, September.
  29. Buettner, Thiess, 2003. "Tax base effects and fiscal externalities of local capital taxation: evidence from a panel of German jurisdictions," Journal of Urban Economics, Elsevier, vol. 54(1), pages 110-128, July.
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