Theories of inter-jurisdictional tax-competition, yardstick competition and expenditure spillovers all assume fiscal decisions of one jurisdiction to influence fiscal decisions of other jurisdictions. This paper empirically addresses the issue if the income tax setting behavior by one local government influence the tax setting behavior of other local governments. The main purpose of this paper is to test for inter-jurisdictional influence in tax setting behavior across Swedish jurisdictions. In particular, the aims in this paper is to answer two questions: 1) Do the local tax level in one jurisdiction depend on the tax level in other jurisdictions, and 2) Do tax adjustments in one jurisdiction depend on tax adjustments in other jurisdictions. The empirical strategy is to use spatial econometric methods to estimate fiscal reaction functions where, conditional on other covariates, the tax rate in one jurisdiction depends on the tax rates in other jurisdictions. In the previous literature it is often assumed that interaction only exist among geographically close jurisdictions such as jurisdictions who share a common border or are within a pre-defined geographical distance. Although such definition are reasonable, it is also reasonable to define closeness based on distance in for instance population size or population density, age structure and political preferences. That is, a densely populated jurisdiction may relate and more influenced by the tax setting behavior by other densely populated jurisdictions compared to geographically closer but small jurisdictions. Moreover, we also allow for sequential decision making in that the tax decision made by municipality at time depend on the tax rate in a neighbouring municipality at time .
A data set covering all 290 Swedish municipalities between 2003-2016 constitute the base of analysis. One advantage of using data on local Swedish governments is that they have for long enjoyed considerable autonomy from the national government in that they set their own budget, make their own priorities and exercise powers of income taxation. Another advantage of is that since they work within the same legal and institutional system, many of the problems associated with cross-country studies are avoided. Our results points in the direction of no or small effects.