Fiscal competition over taxes and public inputs

Governments are widely perceived as competing for capital by choosing parameters in a multi-dimensional policy space. We consider the choice of a business tax rate as well as a productive public input by local governments and estimate a model of strategic interaction in both policy instruments. The estimations suggest that local governments use both the business tax rate and public inputs to compete for capital. We find that if neighbors cut their tax rates, governments try to restore competitiveness by lowering their own tax and increasing public inputs. If neighbors provide more infrastructure, governments react by increasing their own spending.

► We estimate a model of tax and public input competition by local governments. ► We find that governments use both policy instruments to compete for capital. ► Governments react to lower taxes by cutting their own tax and increasing public inputs. ► Governments react to higher public inputs by increasing their own spending on inputs.