City competition for the creative class

Abstract

This paper explores the conditions under which decentralization and fiscal competition lead to a policy of providing public amenities in order to attract highly productive labor. It provides a theoretical analysis which shows that the incentive to provide such amenities is particularly strong, if institutional restrictions prevent local governments from adjusting their tax structure. The empirical analysis considers the case of Germany, where public subsidies to local theaters are shown to exert a compensating earnings differential for highly educated labor. Taking account of the institutional setting, our empirical results suggest that local jurisdictions in Germany are subject to a substantial fiscal incentive to subsidize cultural activities.