Determinants of Tax Rates in Local Capital Income Taxation: A Theoretical Model and Evidence from Germany

Thiess Büttner

FinanzArchiv: Public Finance Analysis, 1999, vol. 56, issue 3/4, 363-

Abstract: In a theoretical model local jurisdictions provide a public input and a public consumption good financed by a tax on capital income. When deciding about tax rate and budget structure the jurisdictions will generally respond to each other's fiscal choices irrespective of whether their policy is oriented more towards raising local income or raising public consumption. These policy differences along with differences in size are then shown to give rise to local differences in tax rates. The theoretical implications for the distribution of tax rates are then confronted with the case of local business taxation (Gewerbesteuer) in West Germany. Taking into account local interdependence in tax rate decisions, tax rates are found to be positively related to the population size of the communities even when controlling for density. This conforms with the hypothesis that large jurisdictions experience some market power in the capital market. In addition, federally mandated local welfare expenses are established as a determinant of local tax differences raising concerns about distortions induced by the German federal system.

Date: 1999
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