Economic Consequences of Local Public Good Provision: Empirical Evidence on Firm Responses and Economic Incidence

• Applicants: Professorin Dr. Nadine Riedel; Dr. Martin Simmler
• Subject Area: Economic Policy, Applied Economics
• Term: from 2014 to 2018
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 260627621

Recent decades have seen an unprecedented increase in capital mobility across jurisdictional borders, implying that governments have an incentive to adjust their fiscal policies in order to attract firms and investment. While the impact of corporate taxes on firms' location and investment choices has been investigated extensively in the empirical literature, potential effects related to the provision of public inputs, goods and services (PIGS) have largely been ignored. The aim of this project is to fill this gap. To do so, we create a unique panel data set which links information on the full scale of PIGS provision in German municipalities (including e.g. data on publicly funded infrastructure, education, recreation facilities and culture) to information on the location of the universe of firms operating in Germany and data on the size of corporate investments. Effect on Firm Location and InvestmentIn a first step, we determine the direct impact of municipal PIGS provision on corporate location and investment choices. Methodologically, we estimate panel models, which control for observed and unobserved heterogeneity across communities and implement instrumental variable strategies. In order to assess and quantify the welfare consequences of interjurisdictional fiscal competition, we additionally implement spatial econometric models, which test for fiscal externalities of PIGS on corporate activity in neighboring localities. The project further assesses whether communities can reduce exposure to competitive interjurisdictional pressure by differentiating their PIGS provision from other communities, helping them to attract and retain firms that highly value their set of PIGS. Our data allows us to test two implications of this Tiebout-mechanism: firstly, we analyze whether German communities are differentiated in terms of their PIGS and secondly, we assess whether changes in the provision of PIGS exert heterogeneous effects on firm decisions depending on their business and workforce characteristics. On top, we test for potential interactions between PIGS provision and agglomeration economies in driving corporate location and investment choices and assess the role of agglomeration rents in dampening interjurisdictional fiscal competition.IncidenceOur data furthermore allows determining the beneficiaries of PIGS provision. To do so, we identify the causal effect of PIGS provision on wages, property prices and corporate profitability using linked employer-employee data and property price information for German communities. Corporate TaxationFinally, our project allows us to reassess the impact of corporate taxation on corporate location and investment choices as well as wages and house prices. As previous work largely fails to appropriately control for PIGS provision, and corporate taxes and PIGS provision are linked via the public budget, existing estimates are likely biased.

• DFG Programme: Research Grants
• International Connection: United Kingdom