Yardstick competition and partial coordination: Exploring the empirical distribution of local business tax rates

Abstract

This paper explores a striking form of tax policy interdependence that can be observed in the German federation. Though municipalities enjoy discretion in setting the local business tax rate, large fractions of municipalities – in some states even the majority – set identical tax rates. Our analysis shows that this tax-rate “bunching” is not the result of federal or state-level institutions. Possible explanations rest on partial coordination and yardstick competition. The role of the former is exemplified by the finding that small jurisdictions and jurisdictions sharing the same county are more likely to engage in “bunching”. Yardstick competition seems also relevant since jurisdictions for which strategic tax-setting should be associated with larger gains and lower cost are in fact more likely to set identical tax rates.