Working Papers

2009-29 | June 2010

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Can Lower Tax Rates Be Bought? Business Rent-Seeking and Tax Competition Among U.S. States

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The standard model of strategic tax competition – the non-cooperative tax-setting behavior of jurisdictions competing for a mobile capital tax base – assumes that government policymakers are perfectly benevolent, acting solely to maximize the utility of the representative resident in their jurisdiction. We depart from this assumption by allowing for the possibility that policymakers also may be influenced by the rent-seeking (lobbying) behavior of businesses. Businesses recognize the factors affecting policymakers’ welfare and may make campaign contributions to influence tax policy. This extension to the standard strategic tax competition model implies that business contributions may affect not only the levels of equilibrium tax rates but also the slope of the tax reaction function between jurisdictions. Thus, business campaign contributions may directly influence business tax rates, as well as indirectly shape tax competition, and enhance or retard the mobility of capital across jurisdictions. Based on a panel of 48 U.S. states and unique data on business campaign contributions, our empirical work uncovers four key results. First, we document a significant direct effect of business contributions on tax policy. Second, the economic value of a $1 business campaign contribution in terms of lower state corporate taxes is approximately $6.65. Third, the slope of the reaction function between tax policy in a given state and the tax policies of its competitive states is negative, and this slope is robust to business campaign contributions. Fourth, we document the sensitivity of the empirical results to state effects.

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