Horizontal interactions in local personal income taxes

Abstract

Theories of inter-jurisdictional tax and yardstick competition assume that the tax decisions of one jurisdiction will influence the tax decisions of other jurisdictions. This paper empirically addresses the issue of horizontal dependence in local personal income tax rates across jurisdictions. Based on a large data set covering Swedish municipalities over a period of 14 years, we test for interactions across municipalities that share a common border, across municipalities within a distance of 100 km of each other, and across municipalities with similar political representation in the local council. We also test the hypothesis that the tax rate of relatively larger municipalities has a greater influence on their neighbors' tax rate compared to the influence of their smaller neighbors. Our results suggest that when lagged tax rates are controlled for, the horizontal correlation across municipalities that share a common border or are within a distance of 100 km from each other becomes insignificant. This result is of importance as it suggests that lagged tax rates should be included or at least tested for when testing for horizontal interactions or mimicking in local tax rates. However, our results support the hypothesis of horizontal interactions across municipalities that share a common border when the influence of neighboring municipalities is also weighted by their relative population size, i.e. relatively larger neighbors tend to have a greater impact on their neighbor's tax rates than their relatively smaller neighbors. This is of importance as it suggests that distance or proximity matters, although only in combination with the relative population size. We also find some evidence of horizontal dependence across municipalities with similar political preferences.

Fiscal Externalities in Multilevel Tax Structures: Evidence from Concurrent Income Taxation

“…In addition, it is frequent for high-income taxpayers in …scally decentralized structures to adopt tax planning strategies such as transferring personal assets or their residency to lower taxed jurisdictions, irrespective of the e¤ective location of their business or employment (Milligan and Smart, 2019). Given the potential threat that income tax base mobility poses on the ability of governments to collect revenues to provide public services and achieve the desired degree of income redistribution, the issue has been attracting increasing interest in the applied public economics literature in the most recent years (Basten et al, 2017; Schmidheiny and Slotwinski, 2018; Agrawal and Foremny, 2019; Eugster and Parchet, 2019; Lundberg, 2021). Indeed, a well-known consequence of the income tax base responsiveness to …scal di¤erentials is that decentralized tax setting decisions will end up being interdependent due to the …scal externality that each authority in ‡icts on the other authorities when setting its own policy, possibly leading to an ine¢ cient 'race to the bottom' in income tax rates -a phenomenon of substantive policy relevance (Kleven et al, 2020).…”