The efficiency and distributive effects of local taxes: evidence from Italian municipalities

Summary

Different levels of tax progressivity between fiscal jurisdictions might trigger a host of taxpayers’ behavioral responses intended to minimize the tax burden. This paper uses panel data from municipality-level tax returns to study the effect of local income tax policy on taxable income and its distribution. Exploiting a reform that granted municipalities the authority to switch from a flat to a progressive local tax scheme on personal income and implementing a difference-in-differences analysis, I find a significant negative effect of tax progressivity on both taxable income and inequality. I estimate an elasticity of taxable income with respect to the net-of-local tax rate of 0.55; the response is mostly concentrated among taxpayers in the top percentile of the pre-tax income distribution. Combining data on transfers of residence with the differential in tax rates across fiscal jurisdictions, I show that the main findings are consistent with the notion of internal mobility and cross-municipality income shifting within local labor markets to minimize the tax liability.