Considering data for individual earnings we show that the local subsidization of cultural activities in Germany exerts effects on the wage distribution in the sense that these subsidies tend to reduce the wage gap between those with higher and less education. These findings motivate a theoretical analysis which explains the effects of subsidies in terms of a cross-sectional capitalization into the earnings of the immobile factor. In the theoretical model, the local government is focusing on improving the economic conditions faced by immobile residents. In this context, subsidization of cultural activities is discussed as a form of local public goods provision which makes a city more attractive to highly educated individuals who capture the rents from the production process. The theoretical analysis shows that inter-jurisdictional competition for the highly educated introduces a distortion of public goods provision, in the sense that uncoordinated policies lead to an inefficiently large supply of the public good. Our results suggest that since German local governments are prevented from adjusting their tax structure in a way that meets the efficiency requirements under fiscal competition, they resort to extending the supply of cultural activities through public subsidization.
