Local Policy Choice: Theory and Empirics

Abstract

This paper critically surveys the growing literature on the policy choices of local governments. First, we identify various reasons for local government policy interactions, including fiscal competition, bidding for firms, yardstick competition, expenditure spillovers, and Tiebout sorting.We discuss theoretically what parameters should be estimated to determine the reason for competition among local governments. We emphasize how the policy outcomes emerging from this competition are affected by the presence of constraints imposed by higher-level governments. Second, we integrate theoretical and empirical analyses on the effects of fiscal decentralization on mobility, spillovers, fiscal externalities, economic outcomes, and distributional issues. Third, we identify key issues that arise in the empirical estimation of strategic interactions among local governments and highlight recent quasi-experimental evidence that has attempted to identify the mechanism at work. Finally, a synthesis model, containing multiple mechanisms and fiscal instruments, resolves some puzzles and provides guidance for future research.

Pareto-Improving Minimum Corporate Taxation

“…for instance, find that high tax municipalities in Germany responded to binding minima imposed on neighbors by lowering their business tax rate, whileLyytikäinen (2012) finds no significant interaction in property tax rates across Finnish municipalities. Both settings are quite different-respectively, in the even greater disconnect between residents and firm ownership at municipal level, and relative immobility of the base-from that of profit shifting across national borders that is at issue here Agrawal et al (2020). discuss the distinct considerations that shape best responses in tax interactions between local governments.12 See for instanceKempf and Rota-Graziosi (2010) on the question of which country emerges as a leader.13 This Stackelberg point is established in the framework ofKanbur and Keen (1993) byWang (1999); a more general diagrammatic exposition is inKeen and Konrad (2013) Konrad (2009).…”

Horizontal interactions in local personal income taxes

“…However, this is far from easy. As shown by Brueckner (2003), Agrawal et al (2020b) and others, the causes of interaction give rise to similar reduced forms and spatial reaction functions. Nevertheless, many studies point in the direction of yardstick competition.…”

“…As noted by Wildasin (2006), Agrawal et al (2020b) and others, = 0 does not automatically rule out tax competition. For example, = 0 may mean that strategic interactions do not exist among the (small) set of jurisdictions defined as neighbors by but do exist among another set of neighbors.…”

Evaluating State and Local Business Tax Incentives

“…on the agents in the location providing incentives, but also on the agents in all other locations. Much of the literature on tax competition (for a survey, see Agrawal, Hoyt and Wilson (2019)) highlights the possibility of a race to the bottom and over-subsidization of firms. A prisoner's dilemma perspective in which every location acting in their own self-interest, leading to a sub-optimal equilibrium for all helps reveal why some policymakers have called for subsidy bans in the United States (Markell, 2017) and has led to bans on such subsidies within the European Union.…”