A Fistful of Dollars: Rent Seeking Behaviour and Local Tax Manipulation

Abstract

The aim of this paper is to study whether politicians manipulate fiscal policy to extract private rents. We focus on the local personal income tax (PIT), in the setting of Italian cities, which is a progressive instrument that allows mayors to set different rates to distinct wage groups. We exploit discontinuities in mayors’ salaries, that are based on population thresholds, to study whether mayors systematically apply lower rates to their own tax bracket. The main results document large rent-seeking activity in fiscal policy. First, we show that when mayors’s salary is exogenously located in the following tax bracket this receives a significantly lower tax rate than the previous bracket, compared to the control group. Second, we show that this rent-seeking activity is highly detrimental for the public treasury, with a considerable reduction in fiscal revenues. And finally, we document that the monetary gains for rent-seeker politicians are rather limited. These results suggest that when fiscal policy is prone to be manipulated politicians do not hesitate to engage in rent-seeking activities even in case of little profits.

Keywords: rent-seeking, fiscal policy, personal income tax, efficiency wage, regression discontinuity design

JEL Classification: D72, E62, H71, P16