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International Tax and Public Finance

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01.10.2016 | Original Paper

How to stop the race to the bottom

Empirical evidence from North Rhine-Westphalia

verfasst von: Anna Rauch, Caroline-Antonia Hummel

Erschienen in: International Tax and Public Finance | Ausgabe 5/2016

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Abstract

Standard tax multipliers are a widespread feature of fiscal equalization systems. A simple theoretical model shows that actual tax multipliers respond positively to changes in standard tax multipliers. This theoretical prediction is tested empirically using data on municipalities in Germany. A quasi-experiment in the state of North Rhine-Westphalia is exploited to identify the incentive effect. The empirical results confirm that local business tax policy is shaped by standard tax multipliers. They provide a straightforward practical tool to avoid a race to the bottom in local business tax rates.

Vorheriger Artikel Voters prefer more qualified mayors, but does it matter for public finances? Evidence for Germany

Nächster Artikel The political economy of pricing and capacity decisions for congestible local public goods in a federal state

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In contrast to most such systems, German municipal fiscal equalization schemes rely on a comparison between “fiscal need” and “fiscal capacity.” Moreover, the sum of all equalization transfers is typically fixed by the state level and not endogenous.

Weighted average business tax multipliers in Germany increased from 330 in 1980 and 364 in 1990 to 390 in 2010 (Federal Statistical Office 2014c).

Moreover, fiscal equalization between federal states in Germany also employs standard tax rates to standardize property transfer tax revenue since the introduction of state tax rate autonomy for this tax in 2006.

Other relevant sources are the local property tax, the municipal shares of VAT and income tax, as well as duties and charges.

The basic federal tax rate was set at 5 % (with lower rates for operating profits below 48.000 euros) during our sample period. It was reduced to a uniform rate of 3.5 % in 2007.

In addition to such “common” fiscal equalization transfers, some states employ special transfers to municipalities suffering from a very low standardized tax revenue to ensure that they achieve a pre-defined level of fiscal resources. However, this is not the case in North Rhine-Westphalia.

Due to the endogeneity of the basic amount, the comparative statics of municipal fiscal equalization are not straightforward and unknown to municipalities.

Standardized property tax revenue is determined equivalently.

The first-round basic amount becomes:

$$\begin{aligned} \beta _{1}=\frac{\sum \nolimits _{i=1}^{I}T_{i}+\alpha s\left( B_{i}^{0}+\gamma m_{j}-\delta m_{i}+B_{j}^{0}+\gamma m_{i}-\delta m_{j}\right) }{\alpha (N_{i}+N_{j})}. \end{aligned}$$

The differentiation was found to be arbitrary as long as the legislator had not established why it was warranted for objective reasons.

GDP is also missing in 1993.

In 2003, the standard tax multiplier was increased to 403 for all North Rhine-Westphalian communities.

Population size in 1995 determines assignment to treatment groups for the one municipality that grows beyond 150,000 inhabitants in 2000.

Standard tax multipliers were not set exogenously in later reforms (2003, 2011).

Although we distinguish “treated” and “untreated” municipalities, it is important to note that transfer payments to all municipalities were affected by the reform: The sum of all transfers is fixed and the change in the standard tax multiplier affects how this sum is distributed among all municipalities.

As mentioned above, there was another reform in 2003. The incentive effect was stronger for the group of “small” municipalities due to their lower business tax multipliers.

Further potential controls were tested (e.g., debt p.c. and employees p.c.), but were not significant and did not improve goodness of fit.

The slightly higher coefficients in 2001 and in 2002 might be due to anticipating reactions to the 2003 reform.

Baskaran, T. (2014). Identifying local tax mimicking with administrative borders and a policy reform. Journal of Public Economics, 118, 41–51.CrossRef

Baskaran, T. (2015). The revenue and base effects of local tax hikes: Evidence from a quasi-experiment. Center for European, Governance and Economic Development Research Discussion Papers (257).

Bucovetsky, S., & Smart, M. (2006). The efficiency consequences of local revenue equalization: Tax competition and tax distortions. Journal of Public Economic Theory, 8(1), 119–144.CrossRef

Büttner, T. (2006). The incentive effect of fiscal equalization transfers on tax policy. Journal of Public Economics, 90(3), 477–497.CrossRef

Büttner, T., Holm-Hadulla, F., Parsche, R., & Starbatty, C. (2008). Analyse und Weiterentwicklung des Kommunalen Finanzausgleichs in Nordrhein-Westfalen: Gutachten im Auftrag des Innenministeriums des Landes Nordrhein-Westfalen.

Egger, P., Köthenbürger, M., & Smart, M. (2010). Do fiscal transfers alleviate business tax competition? Evidence from Germany. Journal of Public Economics, 94(3–4), 235–246.CrossRef

Federal Statistical Office. (2014a). Fachserie 14 Reihe 4: Finanzen und Steuern 2013.

Federal Statistical Office. (2014b). Pressemitteilung 109/14 (21.03.2014): Kommunen erzielten im Jahr 2013 einen Überschuss von 1,1 Milliarden Euro.

Federal Statistical Office. (2014c). Realsteueraufkommen und gewogene Durchschnittshebesätze ab 1949 (F 310/37123100).

Goerl, C.-A., Rauch, A., & Thöne, M. (2013). Weiterentwicklung des kommunalen Finanzausgleichs in Nordrhein-Westfalen.

Köthenbürger, M. (2002). Tax competition and fiscal equalization. International Tax and Public Finance, 9, 391–408.CrossRef

Oates, W. E. (1972). Fiscal federalism. New York: Harcourt Brace Jovanovich.

Parsche, R., & Steinherr, M. (1995). Der kommunale Finanzausgleich des Landes Nordrhein-Westfalen: Gutachten im Auftrag des Innenministeriums des Landes Nordrhein-Westfalen.

Raudla, R. (2010). Governing budgetary commons: What can we learn from Elinor Ostrom? European Journal of Law and Economics, 30(3), 201–221.CrossRef

Smart, M. (2007). Raising taxes through equalization. Canadian Journal of Economics, 40(4), 1188–1212.CrossRef

Titel: How to stop the race to the bottom
Empirical evidence from North Rhine-Westphalia
verfasst von: Anna Rauch
Caroline-Antonia Hummel
Publikationsdatum: 01.10.2016
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 5/2016
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-015-9387-7

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