9.4 Fiscal competition among jurisdictions

Fiscal competition among jurisdictions is a key factor shaping urban fiscal policies. It involves governments vying to attract residents and businesses through strategic tax and public service decisions. This competition influences resource allocation and impacts local government behavior.

The process assumes rational actors respond to fiscal incentives by "voting with their feet." It can take various forms, including horizontal competition between similar jurisdictions and vertical competition between different government levels. Tools used range from tax incentives to infrastructure investments.

Concept of fiscal competition

• Fiscal competition describes how governments compete to attract residents and businesses through tax policies and public services
• Plays a crucial role in shaping urban fiscal policies by influencing resource allocation and public investment decisions
• Impacts local government behavior and affects the distribution of economic activity across jurisdictions

Definition and basic principles

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• Process where jurisdictions compete for mobile tax bases by adjusting fiscal policies
• Driven by the desire to attract and retain residents, businesses, and capital
• Involves strategic decision-making regarding tax rates, public spending, and regulatory policies
• Assumes rational actors respond to fiscal incentives by "voting with their feet"

Types of fiscal competition

• Horizontal competition occurs between jurisdictions at the same governmental level (cities, states)
• Vertical competition takes place between different levels of government (local vs state)
• Tax competition focuses on lowering tax burdens to attract economic activity
• Expenditure competition involves offering superior public services or amenities
• Regulatory competition centers on creating business-friendly environments through less stringent rules

Factors influencing fiscal competition

Geographic proximity

• Neighboring jurisdictions more likely to engage in direct competition
• Spatial clustering of similar policies due to spillover effects and policy diffusion
• Cross-border shopping and commuting patterns influence competitive pressures
• Regional economic interdependencies shape the intensity of fiscal competition

Economic conditions

• Business cycles affect the degree and nature of fiscal competition
• Economic growth rates impact the resources available for competitive strategies
• Industry composition determines the types of fiscal policies most effective in attracting investment
• Labor market conditions influence the mobility of workers and firms

Political structures

• Federal systems tend to foster more fiscal competition than unitary governments
• Degree of fiscal decentralization affects the autonomy of local jurisdictions to compete
• Electoral systems shape political incentives for engaging in fiscal competition
• Intergovernmental relations and revenue-sharing arrangements impact competitive dynamics

Tools for fiscal competition

Tax incentives and breaks

• Property tax abatements to attract new development or retain existing businesses
• Corporate income tax credits for job creation or capital investment
• Sales tax exemptions for specific industries or activities
• Tax increment financing (TIF) districts to fund infrastructure improvements
• Enterprise zones offering multiple tax benefits in targeted geographic areas

Public service provision

• High-quality education systems to attract families and skilled workers
• Enhanced public safety measures to improve quality of life and business environment
• Cultural amenities and recreational facilities to increase location attractiveness
• Efficient transportation networks to facilitate commerce and commuting
• Specialized business services (workforce training, export assistance) to support local firms

Infrastructure investments

• Transportation projects (roads, bridges, public transit) to improve connectivity
• Utility upgrades (water, sewer, broadband) to support business operations
• Industrial parks and business incubators to foster entrepreneurship and cluster development
• Convention centers and sports facilities to boost tourism and entertainment sectors
• Green infrastructure initiatives to enhance environmental sustainability and quality of life

Effects on local governments

Revenue implications

• Potential for erosion of tax base if competition leads to lower effective tax rates
• Increased reliance on non-tax revenue sources (fees, charges) to offset tax reductions
• Shifts in revenue composition may affect fiscal stability and predictability
• Possibility of expanding tax base through successful attraction of new economic activity

Service quality impacts

• Pressure to maintain or improve service levels with potentially constrained resources
• Risk of underfunding essential services to finance competitive tax incentives
• Opportunities for innovation in service delivery to achieve cost efficiencies
• Potential for interjurisdictional cooperation to achieve economies of scale in service provision

Economic development outcomes

• Job creation and retention resulting from successful competitive strategies
• Changes in local economic structure due to targeted industry attraction efforts
• Potential for increased income inequality if competition favors high-skill sectors
• Spillover effects on local supply chains and support services for newly attracted firms

Interjurisdictional mobility

Tiebout model

• Theoretical framework proposing residents "vote with their feet" by choosing jurisdictions
• Assumes perfect mobility, complete information, and numerous competing jurisdictions
• Predicts efficient provision of local public goods through sorting of residents
• Critiqued for unrealistic assumptions but provides insights into fiscal competition dynamics

Household sorting

• Families choose locations based on combinations of taxes, services, and amenities
• School quality often serves as a primary driver of residential location decisions
• Housing prices reflect capitalization of local fiscal packages into property values
• Sorting can lead to increased socioeconomic segregation across jurisdictions

Business relocation decisions

• Firms consider tax burdens, regulatory environment, and available incentives
• Access to skilled labor, suppliers, and markets influences location choices
• Quality of life factors affect ability to attract and retain employees
• Relocation costs and existing investments create "stickiness" in business locations

Policy implications

Race to the bottom vs top

• Concern that competition leads to suboptimal levels of taxation and public services
• Counterargument that competition promotes efficiency and innovation in governance
• Possibility of "race to the top" through high-quality services attracting high-value firms and residents
• Need for balancing competitive pressures with maintaining adequate public goods provision

Efficiency vs equity concerns

• Potential for fiscal competition to improve allocative efficiency of public resources
• Risk of exacerbating regional inequalities if some jurisdictions consistently "lose" competition
• Tension between pursuing growth strategies and addressing distributional concerns
• Debate over appropriate role of higher-level governments in mitigating negative equity impacts

Coordination mechanisms

• Intergovernmental agreements to limit destructive forms of tax competition
• Regional cooperation initiatives to promote shared economic development goals
• Tax base sharing arrangements to reduce fiscal disparities within metropolitan areas
• National or international frameworks to establish "rules of the game" for fiscal competition

Case studies

State-level competition

• Use of targeted tax incentives to attract large manufacturing facilities (auto plants)
• Adoption of right-to-work laws to create more business-friendly labor environments
• Creation of sovereign wealth funds from natural resource revenues to fund public services
• Implementation of no-income-tax policies to attract high-income residents and retirees

Metropolitan area competition

• Suburban communities offering lower property tax rates to attract residents from central cities
• Central business districts providing tax increment financing for office and retail development
• Edge cities emerging as new employment centers through aggressive business attraction efforts
• Inner-ring suburbs reinventing themselves through mixed-use redevelopment projects

International fiscal competition

• Corporate tax rate reductions among OECD countries to maintain competitiveness
• Special economic zones in developing countries offering tax holidays and streamlined regulations
• Tax treaty networks facilitating cross-border investment and reducing double taxation
• Competition for high-net-worth individuals through investor visa programs and preferential tax regimes

Critiques and controversies

Welfare effects

• Debate over whether fiscal competition enhances overall economic welfare
• Concerns about potential overproduction of business incentives relative to social optimum
• Arguments that competition can discipline government spending and promote efficiency
• Questions about long-term sustainability of competitive strategies relying on tax reductions

Distributional consequences

• Risk of shifting tax burden from mobile to immobile factors of production
• Potential for increased inequality between "winning" and "losing" jurisdictions
• Concerns about erosion of progressive tax systems through preferential treatment of capital
• Debate over incidence of tax incentives and who ultimately benefits from competitive policies

Regulatory arbitrage

• Firms exploiting differences in regulatory regimes across jurisdictions
• Concerns about "regulatory races to the bottom" in environmental or labor standards
• Challenges in maintaining effective oversight of multinational corporations
• Tension between promoting business-friendly environments and protecting public interests

Measurement and analysis

Empirical studies

• Analyses of tax elasticities to measure responsiveness of economic activity to fiscal policies
• Event studies examining impacts of specific tax changes or incentive programs
• Comparative case studies of competing jurisdictions' economic performance over time
• Surveys of business location decision-makers to understand factors influencing choices

Econometric approaches

• Difference-in-differences models to estimate effects of policy changes on economic outcomes
• Spatial econometric techniques accounting for geographic spillovers in fiscal competition
• Regression discontinuity designs exploiting policy discontinuities at jurisdictional borders
• Structural models incorporating strategic interactions between competing governments

Data challenges

• Difficulty in isolating effects of fiscal policies from other factors influencing economic activity
• Limited availability of comprehensive, comparable data on local tax rates and incentives
• Endogeneity concerns arising from simultaneous determination of policies and outcomes
• Measurement issues in quantifying the value of non-tax factors (quality of life, amenities)

Future trends

Globalization impacts

• Increased mobility of capital and skilled labor intensifying international fiscal competition
• Growth of digital economy challenging traditional nexus rules for taxation
• Efforts to coordinate tax policies across countries to address base erosion and profit shifting
• Emergence of global cities competing for talent and investment beyond national borders

Technology and remote work

• Shift towards location-independent work reducing importance of physical proximity
• New opportunities for smaller jurisdictions to attract knowledge workers and digital nomads
• Challenges in taxing remote workers and businesses without physical presence
• Potential for "Zoom towns" emerging as new centers of economic activity in rural areas

Environmental considerations

• Growing importance of sustainability in location decisions of firms and households
• Competition to attract green industries and develop low-carbon economies
• Integration of climate resilience into infrastructure investment strategies
• Potential for carbon pricing mechanisms to influence patterns of fiscal competition