Local fiscal policies and their impact on the number and spatial distribution of new firms


We examine the effect of local business taxation and local public good and service (PIGS) provision on the number and spatial distribution of new firms. Testing ground is Germany and we rely on the universe of firm foundations between 1998 and 2006. Methodologically, we estimate fixed effects poisson models coupled with a control function approach. The results suggest that a 1%-decrease in the business tax rate (the PIGS capital stock) raises (lowers) the number of new firms in the policy-changing jurisdiction by 4.6% (0.8%). Business tax reductions, moreover, strongly reduce the number of firm foundations in neighboring municipalities, implying that the aggregate number of new firms remains unchanged; while PIGS provision, on average, does not impact the number of firms in adjacent jurisdictions, negative effects emerge for subsets of PIGS and firms.

Research Highlight 2019

Do better schools and streets attract new businesses?   

The main focus of the Centre’s research is on taxation, as might be expected. However, governments may also affect business decisions through the expenditure side of the budget – in providing public goods. Some of these goods may be directly relevant to business; others may be rather indirect, such as the provision of schooling. 

The continuing reduction in corporation tax rates around the world suggests that the predominant way that governments aim to attract new business is by lowering their tax bills. This research project sets out to ask how far can they also do so by improving the provision of public goods. The project uses data from municipalities in Germany; there is substantial variation between municipalities in respect of both the taxation of business profits and the provision of public goods. The project investigates how far both taxes and public goods provision affects the number of new firms in a jurisdiction. 

The research finds that an increase in the tax rate in a municipality by 1% reduces the number of new businesses by 5% but that an increase in public goods provision by 1% increases the number of new firms by less than 1%. The impact of public goods provision is stronger for employmentintensive firms; it is also stronger for public spending directed to households – for example, spending on schools, parks and public swimming pools.

Overall, though, the research finds that tax policy is a less costly tool to attract new firms into a particular jurisdiction, having a greater effect on location decisions. However, while the policy of reducing tax rates is effective, there is also evidence of a corresponding reduction in the number of new businesses elsewhere. By contrast, the policy of increasing expenditure increases the number of new businesses generally, and does not have the same impact on other jurisdictions.