Tax Reform Narratives in German Municipal Tax Decisions

• Applicant: Dr. Zareh Asatryan
• Subject Area: Economic Policy, Applied Economics
• Term: since 2024
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 540712849

This project studies the economic effects and political drivers of tax reforms using new textual data on politicians' narratives over local tax reform debates. The setting is the sub-national level in Germany, a federal country where local governments have autonomy in fairly rich sets of tax and spending instruments, and where the institutions permit the systematic collection of narrative data on tax reforms based on the meeting minutes of local government councils. Unlike standard datasets, the new narrative data allow to cover not only reforms but also reform proposals that were considered but never adopted, and also to measure economic and political motives behind these reforms and reform proposals at a granular level. First, the data makes the identification of the causal impact of tax reforms on local economies possible, and doing so under different government spending scenarios. This is achieved by comparing municipalities with tax reforms to empirically observable counterfactual municipalities where similar tax reforms were proposed but which failed to pass with a small vote margin. Albeit the substantial attention of the literature on estimating credible tax multipliers, the task has not been an easy one given that tax reform decisions are endogenously nested in the economics as well as politics of societies in complicated ways. Second, the narrative data enables constructing peer-to-peer networks of competition among German municipalities as perceived by policymakers, and then studying the effects of taxes in an environment where strategic interactions in tax-setting across jurisdictions are potentially idiosyncratic. This contributes to a fairly large body of work on empirical tax competition by relaxing the almost-universal assumption that jurisdictions compete with each other in some generic form (usually parametrized through some distance and population weighted matrix). Third, in an attempt to contribute to the literature on the political economy of tax reforms, the project measures the motives stated by political parties behind local tax reform proposals. In particular, it identifies the equity and efficiency arguments behind reforms and studies how political competition shapes these motives and their tradeoffs. This helps to understand how politicians in democracies set equity goals, which is important because the political feasibility of tax reforms depends crucially on the equity implications of those reforms. Overall, the new data on tax reform narratives opens several key research frontiers in the large literature on local public economics. In particular, the research agenda contributes to a better understanding of the causal effects of taxes on economic activity, when strategic interactions in tax setting are present and are likely idiosyncratic, and when taxes are determined endogenously in a democratic process of political competition.

• DFG Programme: Research Grants