Identifying Tax-Setting Responses From Local Fiscal Policy Programs

This paper studies tax policy interaction for both mobile and immobile tax bases using German municipality-level data. We exploit exogenous changes in local tax setting associated with state debt reduction programs in Hesse and Northrhine-Westfalia to learn about strategic interaction among local governments when setting their taxes. Our results suggest strong and significant tax policy responses both in corporate as well as in property tax rates. Our estimates imply response function gradients in the range of 0.3 to 0.7, depending on the type of tax and state. Policy spillovers from property tax rates remain very local, which is consistent with yardstick competition behavior.