Politicians' Opinions on Rivals in the Competition for Firms: An Empirical Analysis of Reference Points Near a Border

Many studies of spatial policy interdependence in (local) fiscal policies concentrate on the relations between jurisdictions within a single region. These works usually disregard possible extra-regional effects. In this paper we evaluate the validity of such restriction by focussing on local tax competition. With respect to local corporate tax competition, the intensity of competition for mobile capital between jurisdictions should determine their intensity of strategic interactions in business tax policy. However, as the underlying reality (i.e., competitive forces) is hard to measure objectively, politicians' beliefs about what is real are especially likely to become of crucial importance. For this purpose, we study German local politicians' assessments of their jurisdictions' main competitors in the struggle to attract firms. Our empirical results are based on both OLS and natural spline regressions using survey data from over 700 German municipal leaders in the state of Baden-Württemberg. They show that most politicians perceive other municipalities within their own state as the strongest competitive force. Yet, a crucial caveat to this finding concerns municipalities “near” a border, in which politicians also perceive a strong competitive threat from across the border. This corroborates the idea that municipalities near a border have a broader reference group than is commonly assumed in the existing literature. Moreover, the importance of borders as a dividing line varies depending on the type of border. First, ceteris paribus, their effect is weaker (i.e., less constraining) for national than international borders: this means decision-makers in municipalities up to roughly 20km from the border take competition with jurisdictions beyond the border into consideration when a national, inter-regional border, is concerned, while the equivalent effect of an international border ceases after approximately 12.5km. Second, in our sample the French-German border is shown to have a stronger effect than the Swiss-German border. One tentative explanation is that politicians perceive the cultural dimension of these respective borders (i.e., language) to be more important than the institutional dimension (EU versus non-EU). Alternatively, it could reflect Switzerland's more aggressive corporate tax policy. Overall, our findings suggest that geographically close municipalities perceive each other as competitors for mobile capital regardless of the state or country where they are located. This indicates a need to refine the commonly used contiguity- and distance-based neighbourhood matrices by treating border-municipalities differently from in-land ones to avoid biased estimations of spatial interactions.

Geys, Benny and Steffen Osterloh (2011), Politicians' Opinions on Rivals in the Competition for Firms: An Empirical Analysis of Reference Points Near a Border, ZEW Discussion Paper No. 11-020, Mannheim.