Fiscal Competition and Public Debt
38 Pages Posted: 9 Apr 2016 Last revised: 6 Mar 2018
Date Written: August 9, 2017
This paper explores the implications of high indebtedness for strategic tax setting in internationally integrated capital markets. When public borrowing is constrained due to default, a rise in a country's initial debt level lowers investment in public infrastructure and makes tax setting more aggressive in that country, while the opposite occurs elsewhere. On net a country with higher initial debt becomes a less attractive location. Using data from the universe of German municipalities in an event-study research design we present empirical evidence that is in line with the theoretical model. Our analysis sheds light on proposals to devolve taxing power to lower levels of governments which differ in initial debt levels.
Keywords: Asymmetric Tax Competition, Business Tax, Sovereign Debt, Inter-Jurisdictional Tax Competition
JEL Classification: H25, H63, H73, H87
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