Yardstick competition and fiscal disparities: An experimental study

•Yardstick competition may be biased by the presence of fiscal disparities between local governments.•By means of a laboratory experiment, we successfully test that equalization transfers may mitigate the yardstick bias.•Local tax rates play an important role too. For higher tax rates level yardstick competition is more effective.

Recent theoretical research suggest that yardstick competition may be biased by the presence of fiscal disparities between local governments and that fiscal equalization may help in correcting this bias. This paper provides an empirical test of these theoretical predictions by means of a laboratory experiment.