Strategic Interaction in Tax Policies Among States

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