Tax Mimicking and Yardstick Competition Among Local Governments in the Netherlands

c[circlecopyrt]International Tax and Public Finance, 12, 493513, 2005

2005 Springer Science + Business Media, Inc. Printed in the Netherlands.MAARTEN A. ALLERS [email protected]. PAUL ELHORST [email protected]

Faculty of Economics, University of Groningen, 9700 AV Groningen, The NetherlandsAbstractThis paper provides a spatial-econometric analysis of the setting of property tax rates by Dutch municipalities.

We find evidence of tax mimicking: a ten percent higher property tax rate in neighboring municipalities leads to

a 3.5 percent higher tax rate. Mimicking is less pronounced in municipalities governed by coalitions backed by a

large majority. This points to yardstick competition as the most likely source of tax mimicking. We also find that

Dutch voters seem to be able to penalize incumbents for anticipated tax rate differentials, but not for unanticipated

tax rate differentials. This limits the effectiveness of yardstick competition as a mechanism to reduce political

rent-seeking.Keywords: property tax, tax mimicking, yardstick competition, spatial econometricsJEL Code: D72, H711. IntroductionA number of recent studies show that tax policies are to a considerable extent influenced

by tax policies in neighboring jurisdictions.1 Ladd (1992) shows that an increase in the tax

burden of neighboring US counties of one dollar is matched by an increase of about 50

cents in a countys own tax burden. Similar results were subsequently found by others; see

the studies recorded in Table 1. In these studies, the neighborhood effect typically ranges

from 0.2 to 0.6 per unit of tax.The literature offers three theoretical explanations for tax mimicking: expenditure spillovers, the Tiebout model and yardstick competition. The first theory poses that since expenditure levels are spatially correlated across jurisdictions, so will tax rates. Spatial expenditure

patterns can result from spill-overs: expenditures on local public services can have beneficial

or detrimental effects on nearby jurisdictions. Kelejian and Robinson (1993), for example,

show that police expenditures are higher when police expenditures in neighboring counties

are higher.2The two other theories correspond to the two options open to taxpayers to escape tax

increases: the exit mechanism and the vote mechanism. The exit mechanism, introduced

by Tiebout (1956), is based on the idea that jurisdictions have to compete for a mobile tax

base. If tax rates are high relative to those in neighboring jurisdictions, firms or householdsTax Mimicking and Yardstick Competition Among

Local Governments in...