Business taxation and economic performance in hierarchical government structures

Abstract

This paper models theoretically and investigates empirically the consequences on local economic performance of state mandates on financially distressed authorities. In particular, I analyze the switch from systematic state bailout of regional health care deficits to selectively mandated hikes in regions’ own business income tax rates that took place in Italy around the mid 2000s, and exploit such dramatic switch to identify the impact of tax policy on the economy. I model factor input use within a multi-jurisdiction neoclassical framework, where production takes place in plants, and physical capital requires energy in fixed proportions depending on the size of energy-saving capital that is installed along with physical capital. Energy-saving capital can be interpreted either as tangible information technology (IT) equipment (e.g., computer-aided line speed control devices) or as intangible assets (e.g., process design skills) lowering a plant energy requirement. The estimation results based on panel data for the Italian provinces and regions over a decade (2000-2010) reveal that, by raising the user cost of capital, mandated business income tax hikes stimulate province-level business energy use, lending support to the hypothesis of short run substitution between energy and energy-saving capital, and hamper the employment of human resources in science and technology (S&T) occupations, the latter being interpretable as a proxy for energy-saving capital.