Inertia and Neighboring Effects in Local Tax Policy: Illinois' Experience with a Local Option Tax on Telecommunications

Abstract

Illinois reconfigured the legal basis and constraints for municipal telecommunications taxes in 2003. We use data on municipalities' initial (assigned) tax rate, fiscal condition, population, changes in tax rates of neighboring municipalities and neighbors' initial (assigned) tax rates to explain changes in telecommunications tax rates between 2003 and 2008. We find clear evidence of an important and statistically significant inertia effect—municipalities initially assigned a zero tax rate continued to stay tax free—and important and statistically significant neighboring effects—municipalities whose neighbors changed tax rates did the same, and municipalities whose neighbors were assigned relatively high initial rates increased their own rates faster.