Strategic Tax-Setting in Danish Municipalities? A First Look at the Evidence 2007 - 2017

Peter Nannestad
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Peter Nannestad: Aarhus University

Economics Working Paper from Condorcet Center for political Economy at CREM-CNRS from Condorcet Center for political Economy

Abstract: Denmark has a two-tier tax system. The 98 Danish municipalities have formal authority to levy taxes on income and on land and to set their own (proportional) tax rates. However, since the 1980s central government has increasingly tried to gain influence on the municipalities’ tax-setting behaviour, primarily through yearly agreements with the municipalities’ interest organization. Thus, one might question if in fact Danish municipalities have any leeway any longer when it comes to fixing or changing tax rates. I try to contribute to that debate by examining if Danish municipalities can be shown to engage in strategic tax-setting, i.e. if tax-setting in Danish municipalities is systematically influenced by the tax-setting behaviour of relevant other municipalities. I assume that as a defence against the twin threats of “voice” and “exit” rational politicians will engage in strategic tax-setting whenever they can. Thus, if I do not find evidence of strategic tax-setting, this finding supports the view that Danish municipalities do not have any leeway any longer to determine their own tax rates. On the other hand, to the extent municipalities can be shown to engage in strategic tax-setting, they must have at least some leeway to do so, and their tax-setting behaviour cannot be totally determined by central government. I analyse tax-setting behaviour with respect to the income tax rate, the land tax rate, and a synthetic measure of the municipal tax pressure. The analysis is based on a balanced panel of 98 municipalities over the period 2007-2017. With “relevant other municipalities” defined according to a neighbourhood (common border) criterion and using a SDM specification, I find a statistically significant impact on all three tax rates in a given municipality from the corresponding mean tax rates in its neighbours, although in substantial terms the effect is rather small when it comes to the land tax rate. Furthermore, these effects cannot be ascribed to spatially correlated shocks in included or omitted exogenous variables. I conclude that Danish municipalities must still have some autonomy when it comes to decentralized tax-setting.

Date: 2019-09
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