Political theory suggests that large firms are more likely to engage in lobbying behaviour and have better bargaining positions against their host governments than smaller entities. Conditional on jurisdiction size, public policy choices are thus predicted to depend on the shape of a jurisdiction’s firm size distribution, with more business-friendly policies being enacted if economic activity is concentrated in a smaller number of entities. The research examines this issue in the context of the setting of local business taxes by German municipalities; these account for around 40% of German corporate taxes. The empirical approach exploits rich variation in the distribution of firm sizes within each locality. The research also exploits an exogenous change to boundaries which reduced the number of municipalities in the state of SachsenAnhalt from around 1000 to around 200. The results indicate that there is an inverse relationship between the concentration of economic activity and the tax choices of municipalities, which supports the hypothesis that the rising importance of large businesses may trigger shifts towards a more business-friendly design of tax policies.
Tobias Böhm, Nadine Riedel and Martin Simmler. CBT Working Paper 16/05
The importance of large businesses has grown steadily over recent decades, and many observers have raised concerns that the increased concentration of economic activity in large businesses may increase corporate sector influence over government policies. This paper assesses the empirical support for this concern. Using local tax policy in Germany as a testing ground, it finds that jurisdictions that host on average large firms set lower business tax rates. The results would predict that, for example, the city of Wolfsburg would be likely to raise its local business tax rate by 30% if Volkswagen were to relocate its headquarter away from there to another city.
Since the implications of the finding depend on the transmission channel, the research also investigates whether local governments act rationally when setting lower rates, for example because large firms are more mobile, or to maximize their private benefits, for example because large companies are more likely to engage in lobbying activities. The empirical evidence strongly supports the mobility channel, indicating that tax competition plays a significant role. That is, the current corporate tax system in combination with increasing firm mobility does drive down corporate tax rates – however, this depends on the extent to which the tax depends on the location of production.
Martin Simmler and Nadine Riedel, ‘Large and influential: Firm size and governments' corporate tax rate choice’, Canadian Journal of Economics.