Consumption tax competition among governments: Evidence from the United States

Abstract

The paper contributes to a small but growing literature that estimates tax re- action functions of governments competing with other governments. We analyze consumption tax competition between US states, employing a panel of state-level data for 1977-2003. More specifically, we study the impact of a state's spatial characteristics|that is, its size, geographic position, and border length on the strategic interaction with its neighbors. For this purpose, we calculate for each state an average effective consumption tax rate, which covers both sales and excise taxes. In addition, we pay attention to dynamics by including lagged dependent variables in the tax reaction function. We find overwhelming evidence for strategic interaction among state governments, but only partial support for the effect of spatial character- istics on tax setting. Tax competition seems to have lessened in the 1990s compared to the early 1980s.