What Determines the Level of Local Business Property Taxes? What Determines the Level of Local Business Property Taxes?

By David Merriman

Conventional economic theory intuitively holds that local business property taxes, which account for over one-third of the state and local taxes that firms pay, should be efficiently structured in order to recover the exact cost of providing public services to these firms. However, this conceptual thinking does not accord with observed geographic and over-time variation in business taxation. To better explain these discrepancies, the author develops an alternative theoretical model with heterogeneous firms, some of which are more profitable than others in certain locations. This model more precisely captures observed business tax revenues and its implications are empirically tested using a nationally-representative database of effective tax rates for commercial property and owner-occupied housing. The alternative model better reflects the political and policy tradeoffs that local government officials face between balancing the need for government revenue while maintaining an attractive profit-making environment for businesses and attracting firms that will supply jobs for their constituents.

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