The political trend in local government tax setting

Abstract

Previous fiscal studies have paid little attention to the effects of social interaction on local tax setting. This paper seeks to fill this gap by developing a theoretical model in which politicians belonging to the same party interact with each other in order to draw inferences about ideology. This phenomenon produces a mimic effect which is called the political trend. The results of the analysis show that the political trend gives rise to higher income tax rates and to tax mimicking at the local government level. The framework developed also makes it possible to discriminate between Leviathan-type and welfarist-type politicians. The results show that the former are more sensitive than the latter to changes in the average income tax rate of their peers. Moreover, Leviathan-type politicians are less sensitive than benevolent ones to changes in the central government’s income tax rate.