Local governments' monopoly power and local tax reform: Theory and evidence from the U.K.

Abstract

This paper hypothesises the existence of several sources of monopoly power for local governments when the system of local taxation is reformed, by central government. In particular we argue that information asymmetries between tax-payers and (central and local) government at the time of reform provide opportunities for local politicians to set tax levels which differ from those expected in a full information setting. We predict that, compared to pre-reform tax levels, local tax levels post-reform will differ according to four local government characteristics: (i) the size of the seat majority of the ruling local party; (ii) whether the party controlling local government is the same as, or is different from, the ruling party of central government; (iii) whether the local government structure has one or two ‘tiers’ and whether the same party controls both ‘tiers’; and (iv) the degree of indebtedness of the local authority. Testing the model on the U.K. local tax reform of 1990, we find strong evidence consistent with the hypothesis that inter-authority differences in local tax levels reflect differences in the degree of local political monopoly power resulting from information asymmetries. This monopoly power appears to have been used generally, but not exclusively, to raise tax levels.