Public expenditure spillovers: an explanation for heterogeneous tax reaction functions
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Public expenditure spillovers: an explanation for heterogeneous tax reaction functions Rosella Levaggi1 · Paolo M. Panteghini2,3
© The Author(s) 2020
Abstract In this article, we show that spillovers may provide an alternative explanation for the heterogeneity of tax reaction functions under tax competition. In particular, we assume the existence of n ≥ 2 jurisdictions, which compete to attract mobile capital in a context where public expenditure produces spillovers. We show that the latter can lead to asymmetric responses. For instance, jurisdiction i may react positively to a change in the tax rate of jurisdiction j and negatively to the change in jurisdiction z. From a policy point of view, these findings are helpful to understand the mixed results found by the empirical literature, and to analyse the tax reaction functions of city centres and suburban jurisdictions. Keywords Tax competition · Spillovers · Asymmetric reaction Functions JEL Classification H25 · H2 · H4
* Rosella Levaggi [email protected] Paolo M. Panteghini [email protected] 1
Department of Economics and Management, University of Brescia, Via San Faustino 74b, 25122 Brescia, Italy
2
Department of Economics and Management, AccounTax Lab, University of Brescia, Brescia, Italy
3
CESifo, Munich, Germany
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R. Levaggi, P. M. Panteghini
1 Introduction It is well known that mobility of productive factors may affect government fiscal strategies. This phenomenon distorts trade and investment patterns; it erodes national tax bases and shifts part of the tax burden onto less mobile tax bases. For this reason, economists have extensively analysed tax strategies since the pioneering articles by Zodrow and Mieszkowski (1986) and Wilson (1986).1 It is also well known and widely acknowledged that public goods and services may produce both positive and negative spillovers (their existence being well documented by Revelli 2005; Ojede et al. 2018; López et al. 2017; Solé-Ollé 2006; Banzhaf and Chupp 2011; Oates 2002; Ogawa and Wildasin 2009; Oates 2008). Surprisingly, little research deals with the interactions between these two phenomena. We argue that spillovers affect fiscal strategies; their inclusion in tax competition analysis may enrich our understanding of tax competition. The theoretical literature on tax competition shows that when rates are strategic tools, strategic complementarity or strategic substitutability may arise. Despite these efforts, there is agreement neither on the sign of the reaction functions nor on their magnitude (see, for example, Leibrecht and Hochgatterer 2012). The literature shows that tax rates are in most cases strategic complements at an international level (see Devereux et al. 2008; Redoano 2014; Egger and Raff 2015), while they are likely to be strategic substitutes at sub-national or sub-federal level (e.g. Chirinko and Wilson 2017; Parchet 2019). Accordingly, Brueckner and Saavedra (2001) show that strategic substitution may occur when governments maximize a linear ut
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