The Battle of Taxes: Strategic Interaction in Multiple Tax Policies among States1

The theoretical and empirical literature on excise tax competition has focused on the responses of changes in one state’s tax on its neighbors ’ taxes on the same base. For example, previous studies have addressed the question of what happens to the cigarette tax rate in one state if its neighbors ’ cigarette taxes increase. What these studies have not addressed is how a state might adjust other taxes, either other commodity taxes or possible individual income taxes, when its neighbors change their cigarette taxes. Using a panel of the United States ’ state-level data for the period 1977−2002, I address this issue, both theoretically and empirically, in this paper. Specifically, I estimate the reaction functions not for a single tax rate but multiple rates. The results show that a state’s rates on one tax base are affected by neighboring states’ rates on the same tax base or/and other tax bases, thereby implying that strategic competition among state governments occurs beyond one identical tax rate