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Property taxation as incentive for cost control: Empirical evidence for utility services in Norway

By Lars-Erik Borge and Jørn Rattsø

Abstract

Cost control in the public sector is a challenge for political institutions. Theoretical research recently has shown incentive effects of property taxation that can work as a mechanism to hold costs down. We are able to investigate the empirical relevance of this proposition, since local governments in Norway represent a kind of natural experiment where about 30% of them have residential property tax. The framework of the analysis is a bureau producing public services for the local government, and control of slack is related to the budget constraint of the bureau. High costs are understood as the result of an agency problem. In a stylized model of this interaction, we show that property taxation increases the local government budget responsiveness to higher costs if housing demand is not ‘too’ elastic. Both complimentarity between service supply and housing demand and migration equilibrium contribute to the negative relationship hypothesized between the property tax base and the reported costs of the bureau. The econometric analysis confirms significant differences in unit costs dependent on tax structure. Existence of property taxation seems to help overcome the agency problem and reduce costs. The potential problems of endogeneity of the choice of property taxation and unequal comparisons are handled with instrument variables and matching.

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