Tax competition among local governments: Evidence from a property tax reform in Finland

This paper uses a Finnish policy intervention to study tax competition among local governments. Changes in the statutory lower limits to the property tax rates are used as a source of exogenous variation to estimate the responses of municipalities to tax rates in their neighboring municipalities. I do not find evidence of interdependence in property tax rates among Finnish municipalities. The results are in contrast to the earlier empirical literature, using data from other countries, that has mainly found positive interdependence in tax rates. I compare the causal estimates based on the policy change to the commonly used Spatial Lag estimates and Spatial Instrumental Variables estimates, which are based on highly restrictive assumptions. The comparisons suggest that the standard spatial econometrics methods may have a tendency to overestimate the degree of interdependence in tax rates.

► I study the responses of municipalities to taxes in their neighbor municipalities. ► I use a policy intervention as a source of exogenous variation in property tax rates. ► I find no evidence of property tax competition between Finnish municipalities. ► Standard spatial econometrics methods give biased results.