Do Local Governments Engage in Strategic Property—Tax Competition?

This paper uses spatial econometric methods to investigate property-tax competition among local governments. The theoretical model is drawn from the literature on tax competition, in which local jurisdictions choose property—tax rates taking into account the migration of mobile capital in response to tax differentials. Using a "spatial lag" econometric model, the paper estimates the reaction function of the representative community, which relates the community's property-tax rate to its own characteristics and to the tax rates in competing communities. A nonzero reaction-function slope indicates the presence of strategic interaction in the choice of tax rates. The estimation uses cross-section data on property taxes and other socio-economic variables for cities in the Boston metropolitan area. The results, which are presented for two periods before and after imposition of Proposition 2½ (a tax limitation measure), indicate the presence of strategic interaction.