Tax mimiching and electoral control:: an empirical analusis of local tax setting

Do local governments mimic the tax rates set by other governments? Which groups of governments are used as a yardstick? Does this behaviour arise as a result of political considerations? In this paper we try to find answers to these questions, testing the mimicking hypothesis on a sample of Spanish municipalities during the period 1992-99. With this purpose we estimate equations that pick up the determinants of the main municipal tax rate choices (i.e., property, vehicle and business taxes), including the tax rates set by other municipalities. The estimation is carried out by instrumental variables, using as instruments some of the determinants of neighbour�s tax rates. The link of tax mimicking and political factors is tested by introducing in the equation measures of the electoral margin faced by the incumbent and interactions among these variables and the tax rates set by other municipalities. The empirical results confirm the relevance of the mimicking behaviour in the choice of property and vehicle tax rates. An increase in each of these tax rates in a municipality prompts a positive response in the tax rates of its neighbour�s. The results also suggest that political forces play a role in the explanation of the mimicking behaviour of local officials, since tax rates are higher and the reaction to tax increases in other municipalities is lower when the electoral margin faced by the incumbent is high