Vertical Competition, Horizontal Competition, and Mobile Capital

Abstract

American states and localities levy several taxes on business capital. Vertical tax competition arises as a state and its local governments tax a common base, while horizontal competition takes place across states, local governments in different states, and between local governments in one state and other states. Our application is unique in focusing on multiple federations and allowance for both intrafederation and interfederation competition. We find negative vertical reaction functions for states and localities indicating that capital tax rates are strategic substitutes. Local tax rates, on the other hand, react positively to other-state tax rates and to the rates of localities elsewhere. State rates are not affected by the rates of localities in other states, but they do react positively to the rates of neighboring states. We find evidence that states behave as Stackelberg leaders in the setting of capital taxes.