Abstract
Due to a reform of the local equalization scheme in 2003, a set of municipalities in the German state of North Rhine-Westphalia (NRW) increased their local property and business tax rates by one to two percentage points, while the remaining municipalities kept their rates constant. I use this variation across municipalities and over time to study the revenue and base effects of local property and business tax hikes in a generalized difference-in-differences design. The results suggest that the property tax hikes had even in the long-run a revenue elasticity of unity. Accordingly, I find no adverse effects on property tax bases. For the business tax, I find no significant effects on revenues and bases. Furthermore, there are also no effects on broader economic outcomes such as local employment, firms’ wage bill, and property prices. Overall, increasing local tax rates by one to two percentage points does not seem to affect the local economy adversely.
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Notes
As instruments, he uses lags of fiscal variables, e.g., the lagged level of debt, the lagged deficit, the lag of the local tax rates, etc. However, lags of these variables are problematic instruments, for example, if they are autocorrelated.
Lang and Jian (2004) offer similar evidence.
Municipalities also levy a local tax on agricultural properties, the property tax A. However, revenues from this tax are negligible (e.g., only 37 million Euros or 0.002% of total local tax revenues in 2010 across NRW). I therefore ignore this tax in the following and refer to the property tax B simply as property tax.
Overall, roughly 40% of current local revenues derive from taxes, 16% from equalization transfers, and the remainder from various other sources (e.g., other transfers, independent economic activity by municipalities, fees, contributions, etc.). See Appendix Table 14 for a detailed breakdown. Note also that tax revenues include both revenues from various local taxes over which local governments have complete tax autonomy, notably the property B and the business tax, but also many minor local taxes, as well as revenues from shared federal taxes where municipalities cannot adjust rates or bases, notably the income tax.
Incorporated firms must also pay a federal corporate tax for which rates do not vary across municipalities.
The process by which the value of a property is assessed is codified by federal law and takes into account the age of a building, its location, etc.
For example, one-family dwellings have a different value than two-family dwellings.
Note that profits as defined by the tax laws are only partially related to “true” economic profits (in particular they do not fully account for the cost of capital). There are some further adjustments due to which the tax base for the local business tax deviates from the income and corporate tax bases. These cover in particular interest payments and other capital costs, which are not deductible and thus effectively treated as profits, as well as rent payments, which can only be partly deducted. Note that regulations regarding these adjustments are the same for all municipalities in the Germany.
For non-incorporated firms, the Steuermesszahl varied according to the earnings. The highest rate was \(5\%\) and was applied to firms with earnings above 48,000 Euro.
In 2010, the total volume of transfers was about 5 bn. Euros.
Note that the property tax A revenues also enter the formula for fiscal capacity.
The most important of the other taxes is the income tax. Income tax rates are set at the federal level and do not vary across municipalities, but municipalities are entitled to a fraction of the revenues raised from their inhabitants. As municipalities have no autonomy over the income tax, I ignore it in the following. I also ignore any other tax revenues that enter the formula as these revenues are relatively insignificant.
Note also that the value of \(d_{i,t-1,m}\) does not matter for how a change in hypothetical multipliers affects transfers to a given municipality as this parameter cancels out.
For example, local officials often claim that choosing a tax multiplier below the hypothetical multipliers will result in lower transfers, see, e.g., http://www.derwesten.de/staedte/nachrichten-aus-brilon-marsberg-und-olsberg/steuererhoehung-fast-schon-pflicht-id9803191.html. I explore in Appendix Table 12 the political consequences of the tax hikes. Overall, the results suggest that their political consequences were limited. In particular, there was no backlash against the parties most likely to be held responsible for the tax hikes. I describe these results in more detail below in footnote 37.
Many further details could be incorporated as further determinants of tax bases. For example, there could be cross-tax base effects, where the business tax affects the base of the property tax and vice versa (Dahlby and Ferede 2012). Additionally, tax competition could be explicitly modeled by incorporating the tax rate in other municipalities as a determinant of the tax base in municipality i. I abstract from these complications in the following.
Of course, as both tax rates and transfers are endogenous variables, they will be determined jointly in equilibrium. Thus, even if hypothetical multipliers have no direct effect on transfers, they may be correlated with transfers in equilibrium if local tax hikes have negative base effects.
For example, tax hikes may lead to an outmigration of firms and residents, thereby lowering bases. A decline in bases will in turn increase transfers.
I have also attempted to re-estimate the baseline models reported below after dropping municipalities that increased both their business and property tax multipliers in 2003. Such a regression is not meaningful for the business tax because there is only one municipality that increased its business tax but not its property tax in 2003 (see Fig. 3). For the property tax, however, I get similar results as in the baseline regressions.
The corresponding regression tables for the baseline results can be found in Appendix.
Note that transfers are zero for many observations (these are abundant municipalities as per Eq. 5). I therefore add 1 Euro to all observations prior to taking the log.
I omit the corresponding generalized diff-in-diff figures to save space. They are available upon request.
I have also explored whether there is a significant treatment effect on transfer receipts using the generalized difference-in-differences framework and find no strong evidence for this. The results are available upon request.
I thank an anonymous referee for pointing this out.
As above, the corresponding diff-in-diff figures are available upon request.
Note that the data on expenditures is only available until 2008. Due to changes in the public accounting system, the expenditure data before and after 2008 are not comparable (Christofzik and Kessing 2018).
Again as above, the corresponding diff-in-diff figures are available upon request.
Data source: State Statistical Offices of Lower Saxony and Hesse.
Baskaran (2014) presents evidence that there were also no indirect effects on municipalities in LS, for example, through tax competition, across the joint border.
Data source: State Statistical Office of NRW.
It is unlikely that this small gap, which sets in only in 2005, is due to the changes in hypothetical multipliers. A more likely reason is heterogeneous effects of major federal-wide labor market reforms, which were completed in 2005 (the so-called Hartz IV reforms).
Data source: State Statistical Office of NRW.
For county-free cities, which do not have any subordinate municipalities, I use their actual tax multipliers.
Note that the data on property prices exhibits missing values. To avoid over-time variability in the series merely due to a change in the sample (as some municipalities would in some years drop out of the calculated averages, I interpolate missing values for a county with 5-year averages (using 2 years before and 2 years after the missing observation).
Data source: State Statistical Office of NRW.
However, the findings in Chetty et al. (2011) suggest that frictions are an important reason why only large tax differentials may evoke labor supply responses.
I explore in Appendix Table 12 the political consequences of the tax hikes in NRW. Specifically, I relate the vote share of left-wing, right-wing, and other parties in the council elections of 1999 and 2004 to the treatment dummies defined above. I also explore how the party with the largest vote share in 1999 fares in 2004 in the treated and control municipalities. It is plausible that voters mainly hold the largest party responsible for council decisions on tax policy as there are no formal coalitions at the local level. The results indicate that municipalities that were treated in 2002 are more likely to vote for right-wing parties. However, the size of the effect is only 1.5–2 percentage points, depending on whether the property or business tax hikes are studied. I also find that the largest party witnesses electoral gains rather than losses in municipalities that experienced tax hikes, even if the effect is again relatively small. Overall, it appears that municipalities that experience tax hikes are more likely to vote for (fiscally) conservative parties, but there is no backlash against the party most likely to be held responsible for the hikes (i.e., the largest party in the previous election). As mentioned, the absence of a backlash is plausible in the present context, given that the blame for the tax hikes could at least partially be shifted to the state government.
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Acknowledgements
I am very grateful to the editor and a referee for helpful comments and suggestions. This paper has also benefited from comments by seminar participants at the ZEW Mannheim, the Technical University of Dortmund, and the 2016 European Public Choice Society conference in Freiburg. I am also grateful for financial support (Grant DFG BA 4967/1-2) from the German Research Foundation (DFG).
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Appendix
Appendix
See Tables 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13 and 14
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Baskaran, T. The revenue and base effects of local tax hikes: evidence from a quasi-experiment. Int Tax Public Finance 28, 1472–1518 (2021). https://doi.org/10.1007/s10797-021-09657-2
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DOI: https://doi.org/10.1007/s10797-021-09657-2