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Do Governments Tax Agglomeration Rents?

  • Hyun-Ju Koh
  • Nadine Riedel

Using the German local business tax as a testing ground, we empirically investigate the impact of firm agglomeration on municipal tax setting behavior. The analysis exploits a rich data source on the population of German firms to construct detailed measures for the communities’ agglomeration characteristics. The findings indicate that urbanization and localization economies exert a positive impact on the jurisdictional tax rate choice which confirms predictions of the theoretical New Economic Geography (NEG) literature. Further analysis suggests a qualification of the NEG argument by showing that a municipality’s potential to tax agglomeration rents depends on its firm and industry agglomeration relative to neighboring communities. To account for potential endogeneity problems, our analysis exploits long-lagged population and infrastructure variables as instruments for the agglomeration measures.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2976.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_2976
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