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The Effect of Agglomeration Size on Local Taxes

  • Eva Luthi
  • Kurt Schmidheiny

Standard tax competition models predict a ‘race-to-the-bottom’ of corporate tax rates when firms are mobile. Recent theoretical literature has qualified this view by offering a theoretical explanation why this extreme prediction need not occur: central regions with large clusters of economic activity are able to set positive tax rates without fearing to lose firms to peripheral regions as the firms would forego ‘rents’ from agglomeration economies. In this paper, we study whether local policy makers effectively tax such agglomeration rents. We test this with panel data from Swiss municipalities between 1985 and 2005. We find that large urban areas set indeed higher tax rates than small ones. This is consistent with the theoretical prediction. Within urban areas, however, municipal tax rates are unrelated to the size of economic activity in and around municipalities while they are positively related to the size of the political jurisdiction. We see this result as evidence that the standard tax competition model for asymmetric jurisdictions is at work in the competition of municipalities within an urban area. Both results are robust to controlling for reverse causality by using instrumental variables. Controlling for fixed effects in a 20 year panel is non-informative and neither supports nor contradicts these findings. As a robustness check we introduce an new measure of cluster intensity which considers the varying intensities in agglomeration economies across sectors.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3426.

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Date of creation: 2011
Date of revision:
Handle: RePEc:ces:ceswps:_3426
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  1. Richard E. Baldwin & Paul Krugman, 2002. "Agglomeration, Integration and Tax Harmonization," NBER Working Papers 9290, National Bureau of Economic Research, Inc.
  2. Forslid, Rikard & Andersson, Fredrik, 1999. "Tax Competition and Economic Geography," Research Papers in Economics 2000:5, Stockholm University, Department of Economics.
  3. Mario Jametti & Marius Brülhart & Kurt Schmidheiny, 2007. "Do Agglomeration Economies Reduce the Sensitivity of Firm Location to Tax Differentials?," Working Papers 2007_9, York University, Department of Economics.
  4. Beatrix Eugster & Raphaël Parchet, 2011. "Culture and Taxes: Towards Identifying Tax Competition," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 11.05, Université de Lausanne, Faculté des HEC, DEEP.
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  10. Borck, Rainald & Pfluger, Michael, 2006. "Agglomeration and tax competition," European Economic Review, Elsevier, vol. 50(3), pages 647-668, April.
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  16. Bacher, Hans Ulrich & Brülhart, Marius, 2010. "Progressive Taxes and Firm Births," CEPR Discussion Papers 7830, C.E.P.R. Discussion Papers.
  17. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
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