Local taxes and political influence: evidence from locally dominant firms in German municipalities

Abstract

We analyze the impact of locally dominant firms—i.e. firms that contribute a sizeable share to municipalities’ revenues—on local business tax rates. We argue that these firms have considerable political power locally even if they are not large in the regional or national perspective. These locally dominant firms can use their political power to voice their concerns directly vis-a-vis the local government—a channel of influence that is hardly available in municipalities with an atomistic structure of tax payers. We hypothesize that municipalities with locally dominant firms will set lower tax rates than municipalities in which tax-payers’ concentration is low. We test the impact of tax-payers’ concentration on local business tax rates using data from 423 municipalities in the German state Hesse between 1998 and 2005. The estimation technique accounts for spatial lags and autoregressive disturbances. Results support our central hypothesis: the higher the tax-payers’ concentration, the lower the municipal business tax rates.