The Effects of Fiscal Competition on Local Property and Income Tax Reliance

Abstract This paper examines why local governments rely heavily on the property tax, even when they have access to another revenue source, using data from Ohio’s recent experience of permitting local school districts to use both property taxes and residence-based income taxes. Nechyba’s (1997) theory that local governments’ reliance on the property tax instead of the income tax is due to fiscal competition for relatively high-income residents is tested using data from 610 Ohio school districts. The Ohio residence-based school district income tax is used by only 119 school districts, at low tax rates, to supplement the traditional property tax. The use of a local income tax declines sharply as fiscal competition increases, as measured by the number of nearby school districts. School districts with greater opportunities to export the burden of the property tax to non-residential property owners are less likely to adopt a local income tax.