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Tax Deductibility and Municipal Budget Structure

  • Douglas Holtz-Eakin
  • Harvey S. Rosen

This paper investigates the effects of deductibility of local taxes on communities' budgetary decisions. Our focus is on how changes in the tax price of local spending induced by deductibility affect the mix between deductible and nondeductible revenue sources, and on expenditures. The econometric analysis is based on a rich data set that tracks the fiscal behavior of 172 local governments from 1978 to 1980. We find that the elasticity of deductible taxes with respect to the tax price is in the range -1.2 to -1.6; the tax price has no statistically significant effect on the use of nondeductible revenue sources; and the elasticity of local expenditures with respect to the tax price is about -1.8. Hence, if deductibility were eliminated, we would expect to see a substantial decline in local government spending.

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File URL: http://www.nber.org/papers/w2224.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2224.

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Date of creation: Apr 1987
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Publication status: published as Holtz-Eakin, Douglas and Harvey S. Rosen. "Tax Deductibility and Municipal Budget Structure," Fiscal Federaalism: Quantitative Studies, edited by Harvey S. Rosen. Chicago: UCP, 1988.
Handle: RePEc:nbr:nberwo:2224
Note: PE
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  1. Robert P. Inman, 1985. "Does Deductibility Influence Local Taxation?," NBER Working Papers 1714, National Bureau of Economic Research, Inc.
  2. Daniel R. Feenberg & Harvey S. Rosen, 1985. "The Deductibility of State and Local Taxes: Impact Effects by State and Income Class," NBER Working Papers 1768, National Bureau of Economic Research, Inc.
  3. Martin Feldstein & Gilbert Metcalf, 1986. "The Effect of Federal Tax Deductibility on State and Local Taxes and Spending," NBER Working Papers 1791, National Bureau of Economic Research, Inc.
  4. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  5. White, Halbert, 1982. "Instrumental Variables Regression with Independent Observations," Econometrica, Econometric Society, vol. 50(2), pages 483-99, March.
  6. Hettich, Walter & Winer, Stanley, 1984. "A positive model of tax structure," Journal of Public Economics, Elsevier, vol. 24(1), pages 67-87, June.
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