Large and influential: firm size and governments’ corporate tax rate choice?

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