Abstract
The linkage between federal policy and municipal investment decisions is empirically estimated. The findings of this article indicate that federal policies should be designed with recognition of the potential effects on local investment decisions. Deductibility of state and local taxes is found to have a strong effect on demand for investment. Intergovernmental aid appears to have a small positive influence on investment demand. Investment demand is estimated to have grown after passage of the Tax Reform Act of 1986 (TRA86). Because TRA86 eliminated sales tax deductibility, this suggests that sales taxes are not used at the margin to finance investments. Factors not related to federal tax policy, such as mandates, must explain the subsequent investment growth. Evidence is found that federal policies can increase investment by influencing municipal willingness to issue debt, as measured by the percentage of resources raised through debt. However, the effect disappears when the debt share is simultaneously estimated with investment demand
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