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Local Property and State Income Taxes: The Role of Interjurisdictional Competition and Collusion

  • Thomas J. Nechyba

This paper attempts to address two long standing questions in Public Finance: (i) why is the property tax, despite popular complaints about its fairness, the almost exclusive tax instrument used by local governments, and (ii) why do we consistently observe higher levels of governments undermine local property tax systems through income tax funded grants and state imposed caps on local property tax rates. A new intuitive argument to explain (i) is presented and tested in general equilibrium simulations which utilize a compu- table general equilibrium model of local public finance with parameters set to be consistent with micro-tax data. Different types of agents are endowed with income and houses and are able to move to their most preferred house in their most preferred jurisdiction. Also, agents vote myopically on local property tax rates while non-myopic community planners set a local income tax. Six possible objective functions for community planners are postulated, and all 6 lead to the same equilibrium outcome: community planners will always set local tax rates at or close to zero. When faced with popular sentiment against the property tax, community planners can collude and introduce local income taxes simultaneously to prevent adverse general equilibrium migration and price changes. Since zero income tax rates are dominant strategies however, such an agreement is only enforceable if an outsider like the state government steps in. State grants funded through a state income tax can play such an enforcement role.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5419.

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Date of creation: Jan 1996
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Publication status: published as Journal of Political Economy, 105(2), 351-385, 1997.
Handle: RePEc:nbr:nberwo:5419
Note: PE
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  1. Krelove, R., 1993. "The persistence and inefficiency of property tax finance of local public expenditures," Journal of Public Economics, Elsevier, vol. 51(3), pages 415-435, July.
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  3. Wildasin, David E., 1989. "Interjurisdictional capital mobility: Fiscal externality and a corrective subsidy," Journal of Urban Economics, Elsevier, vol. 25(2), pages 193-212, March.
  4. Pogodzinski, J. M. & Sjoquist, David L., 1993. "Alternative tax regimes in a local public good economy," Journal of Public Economics, Elsevier, vol. 50(1), pages 115-141, January.
  5. Wilson, John Douglas, 1987. "Trade, Capital Mobility, and Tax Competition," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 835-56, August.
  6. Westhoff, Frank, 1977. "Existence of equilibria in economies with a local public good," Journal of Economic Theory, Elsevier, vol. 14(1), pages 84-112, February.
  7. Thomas J. Nechyba, 1996. "Existence of Equilibrium and Stratification in Local and Hierarchical Tiebout Economies with Property Taxes and Voting," NBER Technical Working Papers 0190, National Bureau of Economic Research, Inc.
  8. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
  9. David E. Wildasin, 2005. "Fiscal Competition," Working Papers 2005-05, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  10. Zodrow, George R. & Mieszkowski, Peter, 1986. "Pigou, Tiebout, property taxation, and the underprovision of local public goods," Journal of Urban Economics, Elsevier, vol. 19(3), pages 356-370, May.
  11. Eric A. Hanushek & John M. Quigley, 1978. "An Explicit Model of Intra-Metropolitan Mobility," Land Economics, University of Wisconsin Press, vol. 54(4), pages 411-429.
  12. Ioannides, Yannis M., 1987. "Residential mobility and housing tenure choice," Regional Science and Urban Economics, Elsevier, vol. 17(2), pages 265-287.
  13. Bucovetsky, S., 1991. "Asymmetric tax competition," Journal of Urban Economics, Elsevier, vol. 30(2), pages 167-181, September.
  14. Wildasin, David, 1993. "Fiscal competition and interindustry trade," Regional Science and Urban Economics, Elsevier, vol. 23(3), pages 369-399, July.
  15. Bucovetsky, Sam & Wilson, John Douglas, 1991. "Tax competition with two tax instruments," Regional Science and Urban Economics, Elsevier, vol. 21(3), pages 333-350, November.
  16. Epple, Dennis & Filimon, Radu & Romer, Thomas, 1993. "Existence of voting and housing equilibrium in a system of communities with property taxes," Regional Science and Urban Economics, Elsevier, vol. 23(5), pages 585-610, November.
  17. Wildasin, David E., 1991. "Some rudimetary 'duopolity' theory," Regional Science and Urban Economics, Elsevier, vol. 21(3), pages 393-421, November.
  18. Coates, Dennis, 1993. "Property tax competition in a repeated game," Regional Science and Urban Economics, Elsevier, vol. 23(1), pages 111-119, March.
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