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Local taxes and political influence: evidence from locally dominant firms in German municipalities

Abstract

We analyze the impact of locally dominant firms—i.e. firms that contribute a sizeable share to municipalities’ revenues—on local business tax rates. We argue that these firms have considerable political power locally even if they are not large in the regional or national perspective. These locally dominant firms can use their political power to voice their concerns directly vis-à-vis the local government—a channel of influence that is hardly available in municipalities with an atomistic structure of tax payers. We hypothesize that municipalities with locally dominant firms will set lower tax rates than municipalities in which tax-payers’ concentration is low. We test the impact of tax-payers’ concentration on local business tax rates using data from 423 municipalities in the German state Hesse between 1998 and 2005. The estimation technique accounts for spatial lags and autoregressive disturbances. Results support our central hypothesis: the higher the tax-payers’ concentration, the lower the municipal business tax rates.

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Fig. 1

Notes

  1. 1.

    We cannot rule out the possibility that this result is driven by an alternative interpretation. For details, see Sect. 3.

  2. 2.

    These rents result from the usage of common infrastructure, potentially increasing returns to scale due to clustering of economic activity and local policy promotion of interactions with other private actors or academic institutions which increase productivity (Holmes 1999).

  3. 3.

    Social scientists have compiled a large body of literature on the political influence of large firms in US politics. Drope and Hansen (2006) show that small firms engage in similar lobbying activities though to a smaller extent.

  4. 4.

    Haufler (1997) develops a model of two countries with different political power of labor unions. The difference in bargaining power of labor unions influences the allocation of capital and the business tax rates. Richter et al. (2009) show that firms in the USA can reduce the effective overall tax rate on their profits by lobbying. Unlike the literature reviewed above, they focus on the effect of lobbying on (firm-specific) tax breaks from narrow research and development credits and tax depreciation schedules. The effect on the nominal tax rate is not explored.

  5. 5.

    The mechanism “voice” has received very little attention in the tax and yardstick competition literature so far. Hendrick et al. (2007) are an exception. They find evidence for tax competition in property taxes but not in sales taxes for the Chicago metropolitan area. They conclude that “voice” is important because exit cannot save land-owners from bearing the tax burden of property taxes. Feld (1997) spells out the logic of exit and voice in the context of local income taxation and elements of direct democracy.

  6. 6.

    There are differences in the definition of the tax base for partnerships and corporations. These are of minor importance for the analysis to follow. It should also be noted that the German local business tax before 2008 allowed self-deductibility and thus the effective tax rate was lower than T/TB. However, these rules apply to all municipalities Therefore, we follow the existing studies and use the tax multiplier as central indicator to capture municipalities’ local business tax policies. For further details on the German local business tax, see for instance Scherf (2011).

  7. 7.

    Due to its privacy policy, the Statistical Office could not provide us with the data on the tax payments of the largest firm on the municipal level (not even the sum for the two or three largest firms).

  8. 8.

    Osterloh and Heinemann (2013) show that leftwing politicians are more supportive of harmonizing corporate taxes in the European Union. This results lends further support to our hypothesis.

  9. 9.

    Alternatively, the standardized revenues from the local business tax and local land tax are appropriate measures in this respect. Including standardized business tax revenues also helps to control for the possibility that a high HERFINDAHL variable is associated with an exceptionally large tax base. In this case, the low tax rate in this municipality may not result from fiscal pressure but from the fact that a low tax rate suffices to cover all expenditures. We did not include these variables in the regressions reported in the paper to avoid collinearity: The standardized revenues from the business tax are highly correlated with AV_TAXBASE (r = 0.82), while standardized revenues from the land tax are highly correlated with POP_DENS (r = 0.77). Further collinearity problems emerge from the fact that the fiscal equalization system directly links grants to own tax revenues. However, including standardized tax revenues from land and business taxes does not change the results.

  10. 10.

    This estimation approach follows the estimation theory developed by Kelejian and Prucha (1998, 2010). See also Anselin 1988, p. 186.

  11. 11.

    The displacement in rank for 1998 is more than 40 positions and more than 50 positions for 2004.

  12. 12.

    In the corresponding models, excluding the largest five municipalities requires us to use a new weighting matrix. This new matrix disregards any spatial influence of the five largest municipalities.

  13. 13.

    The difference is similar in 2001 and 2004.

  14. 14.

    We chose this approach and abstained from excluding the metropolitan area from the dataset like we did with the biggest 5 municipalities in table 4. The reason is that—in the spatial regression models used in this paper—excluding municipalities automatically requires to exclude their spatial influence altogether (i.e. exclude them from the weighting matrix).

  15. 15.

    We account for the fact that differences in tax rates between cities and smaller municipalities might result from different expenditure needs. The fact that German cities also have higher land taxes (“Grundsteuer”, which is the other main revenue source of municipalities for which they can choose the tax rate) points in this direction. To account for this, we ran an additional robustness check that follows Geys and Osterloh (2013) and replaces the endogenous variable with the difference between corporate tax rate and land tax rate. The HERFINDAHL variable remains significant, and the coefficient becomes even larger.

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Acknowledgments

We thank Thushyanthan Baskaran Frédéric Blaeschke, Guido Bünstorf, Friedrich Heinemann, Steffen Osterloh, Reinhold Kosfeld and the participants of the Annual meeting of the EPCS 2014 in Cambridge, UK and two anonymous referees for helpful comments.

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Correspondence to Ivo Bischoff.

Appendix

Appendix

See Table 6.

Table 6 Correlation matrix

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Bischoff, I., Krabel, S. Local taxes and political influence: evidence from locally dominant firms in German municipalities. Int Tax Public Finance 24, 313–337 (2017). https://doi.org/10.1007/s10797-016-9419-y

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Keywords

  • Tax competition
  • Lobbying
  • Local business taxation
  • Germany
  • Spatial econometrics

JEL Classification

  • H71
  • C23
  • D72