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Effects of Local Government Revenue Structure on Income Growth and Employment

This research stems from extensive empirical research on effects of taxation and tax structure on economic growth that grows from 1990s onwards. However, most of the empirical research is based on the central (general) government data. The most relevant research is presented by Plosser (1992), Leibfritz, Thornton and Bibbee (1997), Dowrick (1993), Kneller et al. (1999), Bleaney et al. (2001), Widmalm (2001), Padovano and Galli (2002), Gentry and Hubbard (2000). All these studies provide different results on effects of taxes on growth. Plosser (1992) provides the strongest link between taxation and growth up to that date and shows negative effect of personal and corporate income tax on growth. Leibfritz, Thornton and Bibbee (1997) show that direct taxes affect economic growth more negatively from indirect taxes. Dowrick (1993) shows negative impact of personal income tax and insiginificant impact of corporate income tax. Kneller et al. (1999) present less negative effect of consumption tax than personal income tax and property tax. Bleaney et al. (2001) also confirm less distortive effect of consumption taxes. Widmalm (2001), Padovano and Galli (2002), Gentry and Hubbard (2000) determine negative effects of progressivity of the tax system on economic growth. In recent period, the boom in this field of research is initiated by seminal paper of Arnold (2008) which explores relation of tax structures on economic growth of OECD countries. The results of this research show that higher share of corporate and personal income tax relates to significantly lower economic growth. In this sense, it is presented that consumption and property taxes are much more favourable for economic growth than before mentioned direct taxes. In addition, further disaggregation shows that, in terms of growth effects, property taxes are preferable than consumption taxes. Comparable studies with similar results can be found in Johansson et al. (2008) and Arnold et al. (2011). Due to abundance of data, these researches mostly relate to OECD countries data. The results of these studies predominantly show negative effects of direct taxes on growth. Until recent period, the research on effects of tax structure on local government level was very limited. The most of the literature in the field of fiscal federalism from the 1990s was related to the effects of fiscal decentralisation to economic growth. Therefore, the main focus was on the fiscal decentralisation index, i.e. share of local government revenues in total general government revenues. The lack of research on effects of revenue or tax structure on economic growth again comes from the lack of data. In recent period there are several paper that deal with this field, namely Schunk and Porca (2005), Stansel and Swaleheen (2008), Arthur Clarke and Miller (2014). However, all these papers focus on somewhat specific issues. Schunk and Porca (2005) focus on examination of effects on business cycles on state and local government revenue diversification. They conclude that revenue instability caused by business cycle impact causes inefficiencies in local government spending patterns. Therefore, more diverse local government revenue structure enables less volatile local government revenues, and thus, more efficient allocation of local government expenditure. Stansel and Swaleheen (2008) take broader approach and examine relation of “government finance variables”, meaning key items of revenue and expenditure side of the budget, and growth of real per capita income in U.S. metropolitan areas. Due to the lack of data on gross domestic product at local government level variables of income or employment are mostly used to depict economic growth of the local government. Their research supports thesis on negative effect of taxes on income growth. Arthur Clarke and Miller (2014) also study the effects of various expenditures and revenue combinations on growth in real state personal income per capita, using a sample of annual observations from 1977 to 2010 for 49 states and the District of Columbia. In terms of revenue effects, they found that state and local governments underutilize corporate income taxes as a source of revenue. According to their research changing tax structure towards more corporate income tax share would reduce market distortions caused by property taxes, individual income taxes, sales taxes, and federal tax sources. In addition, they conclude that increases in growth occur when property tax, sales tax, and other taxes together with intergovernmental revenue decrease. Before mentioned empirical research, clearly shows the need for more substantive evidence on effects of local government tax structures on economics growth. Thus, based on empirical evidence from a panel of 555 Croatian local governments in period from 2002 – 2013 this paper tries to research effects of local government revenue structure on income growth and employment. Instead of taxes this paper extends more broadly on additional categories of revenue and as well, due to lack of data on local government gross domestic product, relies on income and employment as commonly used measures of economic prosperity on local government level. Such data selection comes from the facts that own tax sources of Croatian local governments are limited. Therefore, the paper focuses both on tax and non-tax revenue sources. Even though the level of entralisation in Croatia is relatively high, there is certain „taxing power“ of the local level driven mainly by setting the rate of surcharge on personal income tax (up to centrally determined maximum levels) and particularly from revenues collected by communal fees and contributions. The rich dataset in this research will enable relevant evidence on effects of local government revenue structure on growth. Of course, the significance of the results will be examined by control variables such as overall share of taxes in income and level of income and employment. There are many policy issues that stem from the proposed research. One of those is whether policy that aims on low level rate of local taxes boosts employment and income. The results will also provide suggestions for changes of local revenue structure and overall changes of intergovernmental fiscal system, i.e. vertical fiscal division. In addition, the paper provides basis for more extensive research related to effects of expenditure structure and also impact of other variables in the field of social and political sciences, such as relation of election participation and demographic trends on economic and fiscal variables.

local government; revenue structure; Income growth; employment; panel data regression

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