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Empirical evidence on horizontal competition in tax enforcement

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Tax auditing parameters have been largely overlooked by the literature as policy-making instruments of any relevance; however, enforcement strategies are critical elements of the tax burden. In this paper, we show that, in a federal framework, tax auditing policies can serve as additional tools for regional interaction. We examine the presence of this interaction by adopting a spatial econometric approach. We employ a spatial panel autoregressive model and obtain results that are congruent with standard theory, corroborating the presence of horizontal competition between regions in their tax auditing policies. We also find that once regional governments acquire legal power, the opaque competition in enforcement policies appears to switch in part to a more transparent competition in statutory tax parameters.

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  1. More specifically, following the 1997 reform, CAs were permitted to modify their tax rate schedules in line with national schedules. Following the 2002 reform, CAs were granted complete legislative control over the tax rates ceded to them by the central government. For a more precise description of these reforms, see Esteller-Moré (2008).

  2. Taxing wealth and wealth transfers is generally unpopular and has become the subject of debate in several OECD countries, including United States and Canada. In Europe, the UK case is highly illustrative: the IGT is popularly ostracized because it raises relatively little revenue, but it is characterized by an excessively high flat rate (40 %). Likewise, it raises issues about double taxation as well as about the absence of effects on wealth distribution (Boadway et al. 2010).

  3. Recently, the European Commission has shown interest in such issues and even though they might arise under different circumstances (i.e. cross-border discrimination and double taxation), it would seem to confirm that questions surrounding the inheritance tax are of growing concern to European citizens (European Commission 2011).

  4. In a decentralized framework, when the principle of residence is applied, an individual finds it profitable to move his fiscal residence to the region with the lowest IGT rate so as to reduce the bequest tax burden.

  5. Spain’s IGT is levied on all goods received from the deceased, valued in accordance with market criteria. As such, a progressive tax schedule subjects heirs (usually the spouse and the descendants) to a high tax liability if they have inherited valuable goods. For this reason, tax avoidance is especially attractive for these taxpayers. As the IGT is residence based, the deceased’s place of residence is key to determining where the inheritors pay the tax and how much they are required to pay. All in all, these circumstances encourage agents, in particular the wealthy elderly, to act strategically given the incentives to elude payment of this tax.

  6. The articles quoted are “Donaciones y sucesiones más baratas, y peajes por encima del IPC”, ABC, 02/01/2008 (available at:; “La competencia fiscal autonómica”, El Periódico de Catalunya 24/10/2007; “La guerra fiscal entre comunidades amenaza el tributo sobre las herencias”, El País 06/05/2007 (available at: and “Imposición autonómica y voto con los pies”, Expansion 22-03-2011 (available at: Among other articles see “Las Cámaras detectan ‘fuga’ de empresas de Cataluña por la competencia fiscal”, El Mundo 21/07/2007 (available at:; “Rosell advierte de que Cataluña puede salir perjudicada por la competencia fiscal con otras autonomias”, El País 04/07/2006; “Madrid atrae herencias catalanas que buscan pagar menos impuestos”, El Periódico de Catalunya 22/07/2007; (available at: and “Grandes bufetes eligen sitios fuera de Cataluña y Andalucía para sus clientes”, Expansión 05/07/2007 (available at:

  7. This mobility can be real but also spurious or fictitious. This is confirmed by the results of a recent survey conducted among tax professionals working in Spain (see Durán-Cabré and Esteller-Moré , 2014). 65 % of respondents agreed in part or fully with the statement that “Regional differences in the inheritance tax have provoked fictitious changes in people’s fiscal residence”. This impression is further confirmed by informal conversations that the authors have maintained with former directors of the regional tax authorities.

  8. As Brueckner notes, “It is important to realize that for strategic interaction (and thus the race to the bottom) to materialize, all that is required is a perception on the part of state governments that generous benefits attract welfare migrants” (Brueckner 2000, p. 508). In our case, rather than generous benefits, it is lax tax auditing policies that can attract taxpayers (or disincentive them to leave), or at least it is perceived in this way by the tax administration.

  9. The applied literature that tests these theoretical models from an empirical point of view is vast and takes a spatial econometric approach (see Anselin 1988). Among others, see for example, Figlio et al. (1999) who examine the simultaneous setting of welfare benefits for the U.S. case; Rork (2003) who analyses competition involving five types of tax (i.e. taxes on cigarettes, gasoline, personal income, general sales and corporate income) for the U.S. case; Devereux et al. (2006) who focus on excise taxes, again for the U.S. case, Devereux et al. (2008) and Overesch and Rincke (2011) who examine corporate taxes for the U.S. and the European cases, respectively.

  10. The model is based on Cremer and Gahvari (2000).

  11. See Appendix  for a generalisation of the model that makes this assumption about the population distribution.

  12. The direct utility function is defined as \(U=B\times \left[ {1-t_i \times \left[ {\alpha +( {1-\alpha })\times \tau \times \beta _i } \right] -g( {1-\alpha })} \right] \), where \(( {\tau -1})>0\) is the exogenous tax penalty per unit of tax evaded and the function \(g(1-\alpha )\) represents the cost of tax evasion \( (1-\alpha )\), such that\( g^{\prime }( {1-\alpha })>0\), \(g^{\prime \prime }( {1-\alpha })>0, g( 0)=0, g( 1)\rightarrow +\infty \).

  13. The psychic benefit from living in region 1is then expressed as \((1-n)\).

  14. Since mobility could be either real or fictitious, this could be interpreted as the cost of actual mobility or the cost of making apparent a fictitious movement.

  15. When the mobility cost is null \(({a=0})\), the tax bases become perfectly mobile: only the pecuniary part of the utility function matters in the taxpayer’s migration decision. By contrast, when the mobility costs are extremely high \((a\rightarrow +\infty )\), the taxpayers are perfectly immobile. This can be interpreted as a centralized economy case in which a sole federal planner sets tax policies. These two limit cases are excluded to allow for imperfect mobility of individuals.

  16. For additional computations, please see Appendix 4 of the working paper version of this study (IEB Working Paper series 2012/005) downloadable at:

  17. While the recent literature suggests that a change in the spatial matrix is not crucial (LeSage and Pace 2010), in our case, the model can be assumed to be better specified than one based on a simple natural neighbours matrix because the Spanish state includes a number of islands, the presence of which makes the definition of neighbours arbitrary (see, for example, Costa-Font and Pons-Novell 2007). However, to check robustness, we also replicate the analysis employing alternative spatial matrixes.

  18. In a spectral-normalized matrix, the (i, j)th element of W becomes w\(^{*}_{ij}\) = w\(_{ij}\)/v, where v is the largest of the moduli of the eigenvalues of W.

  19. As an alternative, we also employed a minmax-normalized matrix (see Drukker et al. 2011) where the (i, j)th element of W becomes w\(^{*}_{ij}\) = w\(_{ij}\)/m and m = min(max(r\(_{i})\),max(c\(_{i}))\), with max(r\(_{i})\) being the largest row sum of W and max(c\(_{i})\) being the largest column sum of W. We do not report the results because they are qualitatively unaffected but they are available on request.

  20. The main heirs are the spouse, descendants/ascendants who with this rule enjoy almost complete exemption. For details on the normative aspect of the exemption regime, see Durán-Cabré and Esteller-Moré (2009, 2010).

  21. The number of inspectors is also taken from the report Informe sobre la cesión de tributos a las Comunidades Autónomas. The variable \(Inspectors_{it} \) is defined as “number of normalized inspectors”: the number of staff members engaged in tax enforcement is conventionally calculated as the weighted sum of inspectors and sub-inspectors considered in function of the months effectively worked.

  22. More specifically, \(TR_{it} \) is a measure of the size of the tax administration in terms of the amount of work it has to process, while \(\mathrm{{Inspectors}}_{it} \) denotes the size of the regional tax authority in terms of the personnel employed in enforcement.

  23. We also estimate two alternative models. In order to test whether the spatial lag is affected by the decentralization process as a whole, we interact the spatial lag with \(\mathrm{{post96}}_{it} \), a dummy equal to one for years posterior to the first IGT reform (1997). With the purpose of emphasizing the effects of the second IGT reform on the process of enforcement competition, we estimate one final model where the spatial lag is interacted solely with \(\mathrm{{post01}}_{it} \). The aim in this case is to emphasize the effects of the second IGT reform on the process of enforcement competition.

  24. We also report the range of critical values for the Stock and Yogo (2005) weak identification test.

  25. The Communities of Navarre and the Basque Country form part of the Foral System, which grants them independence in their laws and tax administrations. For this reason, information about them is not available and they are not included in the paper.

  26. We do not have any information about the administration policies of 1993, as in 1995, the budget had not been approved and data about ceded taxes are two-year lagged. Auditing information for the Madrid Community became available in 1996, the year in which it was granted this administrative power.

  27. The optimal size of the tax administration is not readily determined. The problem has been addressed by equating the marginal social benefit of reduced evasion to the marginal resource cost (Slemrod and Yitzhaki 1987, 2002), which is calculated by assigning a shadow price to the work and time a tax inspector employs in selecting, processing and inspecting a tax return (Yitzhaki and Vakneen 1989).

  28. We performed further analyses (available on request) in order to test whether the relationship of the per-capita deficit and the transfers-expenditure ratio with the tax enforcement was nonlinear but the qualitative results remained unchanged.

  29. As previously stated (see footnote 15), a simple, natural neighbours’ matrix makes the definition of neighbours quite arbitrary in our case due to the presence of islands. Nevertheless, and due to their proximity, we assume the Balearic Islands to be neighbours of the Valencian CA and Catalonia and the Canary Islands to be neighbours of Andalucía.

  30. Indeed, even if the policies were publicly observable (because, for instance, they were recorded in a publicly available report, as is the case in Spain), whether a specific region’s enforcement effort is sufficient or not is not readily established. A low audit rate might be interpreted as being inefficient simply because it is low while it is actually low as a result of improvements which have ensured that the enforcement effort is much more precise and efficient.

  31. This condition is satisfied if the median of the population distribution (\(n_1 )\) coincides with or is higher than the mode of the distribution. This condition can usually be satisfied.


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We would like to thank participants at several conferences and seminars for their helpful comments: specifically, the IEB seminar (University of Barcelona), the “XIX Encuentro de Economía Pública” (University of Santiago de Compostela), the 13th Mediterranean Research Meeting (EUI, Florence), the DSEMS seminar (University of Salento, Lecce), the Workshop on Macroeconomic and Policy Implications of Underground Economy and Tax Evasion (Bocconi University, Milan), the IIPF 2012 Congress (TU, Dresden), the ERSA 2012 Congress (University of Bratislava), the 2012 Spanish Stata Users Group meeting (University of Barcelona) and the VII Tax Day (Max Planck Institute for Tax Law and Public Finance, Munich). We are very grateful to Jordi Jofre-Monseny, Federico Revelli, Jonathan Rork, Albert Solé-Ollé, Pilar Sorribas-Navarro and one anonymous reviewer for their useful comments and suggestions. We are also grateful for funding from the Generalitat de Catalunya (2009SGR102), and from the Ministerio de Ciencia e Innovación (ECO2009-12928 and ECO2012-37873). The usual disclaimers apply.

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Correspondence to Luca Salvadori.


Appendix 1: Generalized results with non-uniform distribution of taxpayers

We assume that the distribution of taxpayers along the home attachment is not uniform, \(i.e.\) we assume that \( n\;\in (0,1)\sim f(n)\) where \(f(n)\) represents a generic density function.

The value \(n_1 ( {t_1 ,\beta _1 ,t_2 ,\beta _2 ;a})=\frac{1}{2}+\frac{U_1 ^*-U_2 ^*}{2a}\) represents the marginal individual indifferent to living in either region 1 or region 2. Below \(n_1 \), we have all the taxpayers that settle in region 1, while above \(n_1 \), there are all the taxpayers that live in region 2. The respective shares of each group are \(F( {n_1 })=\mathop \smallint \nolimits _0^{n_1 } f(n)dn\) and \( 1-F( {n_1 })=\mathop \smallint \nolimits _{n_1 }^1 f(n)dn\).

At stage 1, the problem of the administration of region 1 becomes

$$\begin{aligned} \begin{array}{l} \mathrm{{Max}}\\ {\beta _1 } \\ \end{array} R_1 =F( {n_1 })\times r_1 =F( {n_1 })\times \left[ {B\times \theta _1 -d( {\beta _1 })} \right] . \end{aligned}$$

The FOC of this problem is

$$\begin{aligned} n_{1 \beta _{1}}^{\prime } \times f( {n_1 })\times r_{1}+r_{{1}_{\beta _{1}}}^{'} \times F( {n_1 })\equiv P( {\beta _{1},\beta _{2} ;t_{1} ,t_{2},a})=0. \end{aligned}$$

The SOC is

$$\begin{aligned} P_{\beta _1 } ( {\beta _1 ,\beta _2 ;t_1 ,t_2 ,a})<0. \end{aligned}$$

The slope of the reaction function becomes

$$\begin{aligned} \frac{\partial \beta _1 }{\partial \beta _2 }=-\frac{P_{\beta _2 } ( {\beta _1 ,\beta _2 ;t_1 ,t_2 ,a})}{P_{\beta _1 } ( {\beta _1 ,\beta _2 ;t_1 ,t_2 ,a})}. \end{aligned}$$

This is positive as long as \(f'( {n_1 })\le 0\).Footnote 31

Appendix 2: Comparative statics on a

It is possible to express \(\frac{\partial \beta _1 }{\partial \beta _2 }\) as a function of \(a\) in order to perform a comparative statics analysis:

$$\begin{aligned} \frac{\partial \beta _1 }{\partial \beta _2 }=-\frac{N}{A+a\times \frac{\partial ^2r_1 }{\partial \beta _1 ^2}}=-N\times \left( {A+a\times \frac{\partial ^2r_1 }{\partial \beta _1 ^2}}\right) ^{-1}, \end{aligned}$$


$$\begin{aligned} A&= -2B\times \left[ {\frac{\partial \theta _1 }{\partial \beta _1 }+\frac{\partial g_1 }{\partial \beta _1 }} \right] \times \left[ {B\times \frac{\partial \theta _1 }{\partial \beta _1 }-d^{\prime }( {\beta _1 })} \right] +B\times \left[ {\theta _2 -\theta _1 +g_2 -g_1 } \right] \nonumber \\&\times \left[ {B\times \frac{\partial ^2\theta _1 }{\partial \beta _1 ^2}-d^{\prime \prime }( {\beta _1 })} \right] -\left[ {B\times \theta _1 -d( {\beta _1 })} \right] \times B\times \left[ {\frac{\partial ^2\theta _2 }{\partial \beta _1 ^2}+\frac{\partial ^2g_2 }{\partial \beta _1 ^2}} \right] ,\nonumber \\ \end{aligned}$$


$$\begin{aligned} N=B\times \left[ {\frac{\partial \theta _2 }{\partial \beta _2 }+\frac{\partial g_2 }{\partial \beta _2 }} \right] \times \left[ {B\times \frac{\partial \theta _1 }{\partial \beta _1 }-d^{\prime } ( {\beta _1 })} \right] . \end{aligned}$$

So under FOC and SOC, \(N>0\) and

$$\begin{aligned} \frac{\partial \left( {\frac{\partial \beta _1 }{\partial \beta _2 }}\right) }{\partial a}=\frac{N}{( {A+a\times \frac{\partial ^2r_1 }{\partial \beta _1 ^2}})^2}\times \frac{\partial ^2r_1 }{\partial \beta _1 ^2}<0. \end{aligned}$$

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Durán-Cabré, J.M., Esteller-Moré, A. & Salvadori, L. Empirical evidence on horizontal competition in tax enforcement. Int Tax Public Finance 22, 834–860 (2015).

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