Local Sales Tax Competition and the Effect on County Governments' Tax Rates and Tax Bases

Abstract

Local governments can try to attract retail sales by keeping sales tax rates low and encouraging residents of other jurisdictions to cross-border shop. This predatory behavior must be balanced against the governments' desire to raise revenues. This study examines the extent to which local governments compete and attempt to limit cross-border shopping by changing sales tax rates. I estimate two equations, local sales tax rate and local sales tax base, in the short and long run. The local sales tax rate equation represents the county's tax policy choices and the sales tax base equation represents the demand function for the county businesses' taxable goods and services. The regression results show local governments do consider the sales tax rates of neighboring counties in setting their own rates in both the short and long run. The study also provides evidence that the sales tax rates of the home and competing counties will affect the sales tax base of the home county because shoppers will cross borders to take advantage of differences in tax rates between counties.