Local property and state income taxes: The role of interjurisdictional competition and collusion

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1997-04-01

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Abstract

This paper addresses two long-standing positive questions in public finance: (i) Why is the property tax, despite widespread popular complaints against its fairness, the almost exclusive tax instrument used by local governments, and (ii) why do we consistently observe higher levels of governments (states) undermining local property tax systems through income tax-funded grants and state-imposed caps on local property tax rates? A new intuitive argument to explain question i is presented and tested in simulations using a computable general equilibrium model with parameters set to be consistent with New Jersey data. Both the intuitive argument and the simulation results indicate that setting local income tax rates to zero is a dominant strategy for community planners. When faced with popular sentiment against the property tax, community planners can collude and introduce local income taxes simultaneously to prevent adverse general equilibrium migration and price changes. Since zero income tax rates are dominant strategies, however, such an agreement is enforceable only if an outsider such as the state government steps in. The institution of state grants funded through a state income tax can play such an enforcement role.

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Nechyba

Thomas J. Nechyba

Professor of Economics

Professor Nechyba conducts his research within the fields of public finance, fiscal federalism, and the economics of education. His studies tend toward the investigation of function within local governments, public policy issues concerning disadvantaged families, and the economics behind primary and secondary education. He received funding for one of his latest projects, “An Empirical Investigation of Peer Effects in Schools and of Household Responses to School Policy Changes,” from a National Science Foundation grant. He also received support from the Lincoln Institute for Land Policy for his work, “Urban Sprawl;” from the Spencer Foundation for his study on, “The Role of Peers, Parental Choices, and Neighborhoods;” from the New Zealand Ministry of Education for a study on, “The Impact of Family and Community Resources on Education Outcomes;” and the Hoover Institution for the study, “The Implications of New Federalism.” He also received monetary support from the National Academy of Sciences for his investigation of the fiscal impact of immigrants, and from the Center for Economic Policy Research for various projects concerning education and welfare policy. In addition to his individual research pursuits, Professor Nechyba is also a Research Associate at the National Bureau of Economic Research.


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