Strategic Interaction in Tax Policies Among States

Abstract

Competition among governments differs in several aspects from competition among private agents, in terms of both its positive and normative implications. In this paper we test empirically for strategic interaction among U.S. states in the determination of tax rates on capital income using spatial econometric methods. We find that states have a positively sloped reaction function to the tax policies of rival states. This result has important implications for the comparative statics of the equilibrium configuration of tax rates, because changes in local exogenous variables have cascading effects into other competing states' tax-setting policies. We also find that a state's size has a positive effect on tax rates.