Media Briefings

High Local Taxes Are A Threat To Jobs

  • Published Date: September 2011


Higher local authority taxes reduce employment in existing firms, according to research by
Gilles Duranton, Laurent Gobillon and Henry Overman. But their study, published in the
September 2011 issue of the Economic Journal, also finds that local taxation has no effect
on the entry of new establishments. This is probably because landlords have to lower rents
in high tax local authorities to continue to attract tenants.
Professor Overman comments on the implications for the UK, where local government
finance is currently being debated:
‘Our results suggest that the UK government may be right to worry that local taxation
can negatively affect local employment.
‘One important caveat, however – our results can’t tell us whether local authorities
would actually set such high taxes. They only provide a warning about the negative
employment effects of doing so.’
The UK government recently made clear that it has no intention of allowing local councils to
set their own business tax rates. This is partly a political decision, but the bigger issue is
that it’s not clear what would be the effects of full localisation.
There are several main fears. One is a race to the bottom – local authorities undercutting
their competitors and undermining the tax base. Other fears relate to the opposite scenario.
Would some councils set very high tax rates and waste the revenues on useless
programmes and bureaucracy? Would these very high tax rates bring more pain to firms
already struggling in the face of the recession?
This research assesses the extent to which the second set of fears is justified by
developing new empirical methodologies to identify the effects of local taxation on the
location and growth of firms.
The issue has been the focus of an extensive body of theoretical research and this study is
not the first to consider these issues empirically. Evidence from the 1960s and 1970s
suggested that there was no effect of taxes on firm location decisions. Work focusing on the
1980s suggested a negative relationship and a number of subsequent papers have
confirmed that finding.
But previous research has failed to resolve a central problem when assessing this impact.
Specifically, there are many things about firms and local authorities that we do not observe,
so any correlation between taxes and firm growth needs to be interpreted cautiously
because some third factor (for example, the remoteness of the location) might explain both.
In addition, tax setting may be driven by firm choices rather than vice versa – that is, taxes
may be high because employment is low.
The methodology used in this study solves these problems by using firm level data and
comparing changes over time for firms located on either side of local authority boundaries.
Comparing sites close to local authority borders eliminates major differences (because
closely located sites are assumed to be similar). Comparing firms over time makes it
possible to identify ‘good’ and ‘bad’ firms and so eliminate problems due to the sorting of
firms. In other words, these techniques help eliminate things about local authorities and
firms that are unobserved and which may be responsible for the correlation between taxes
and firm growth.
Finally, using the electoral make-up of the local authority to predict local taxes (some
political parties consistently set higher taxes) means that the researchers can adjust their
results to allow for the possibility that taxes might be high because employment is low.
Using the methodology to study the impact of the UK’s business rates between 1984 and
1989, the researchers find a negative significant relationship between employment and
taxes. Higher local authority taxes lower employment in existing firms. In contrast, local
taxation has no effect on the entry of new establishments, probably because landlords have
to lower rents in high tax local authorities to continue to attract tenants.
ENDS
Notes for editors: ‘Assessing the Effects of Local Taxation Using Microgeographic Data’
by Gilles Duranton, Laurent Gobillon and Henry Overman is published in the September
2011 issue of the Economic Journal.
Gilles Duranton is at the University of Toronto. Laurent Gobillon is at the Institut National
d’Etudes Demographiques in Paris. Henry Overman is director of the Spatial Economics
Research Centre at the London School of Economics (http://spatialeconomics.
blogspot.com/).
For further information: contact Henry Overman on +44 20 7955 6581 (email:
h.g.overman@lse.ac.uk); Romesh Vaitilingam on +44-7768-661095 (email:
romesh@vaitilingam.com).