Are austerity programs successful in reducing deficits and how do they affect public finances and the economy more generally? We examine the consequences a municipal debt relief program by the Hessian state government in 2012 which provided partial debt relief to 78 municipalities while enforcing budget balance. We compile a novel dataset for 421 municipalities (2007-2016 period) and combine propensity score matching with a difference-in-differences design to identify causal effects. Targeted municipalities consolidate their budgets by increasing local property and business tax rates as well as cutting social and personnel expenditures. Overall, we find no adverse effects on local economic activity in bailout municipalities. However, women are more affected by consolidation induced public sector job cuts than men. We also detect a substantial negative impact of program participation on construction activity and house prices (in smaller municipalities).

In decentralized nations like Switzerland and Germany, local taxes are linked to tax schedules determined by superior governments. In such systems, a change to the tax schedule creates a vertical tax externality and affects local governments’ budgets downstream. To investigate this mechanism, I put forward a model of residence-based income tax competition

model with local taxes linked to a federal tax schedule. Comparative statics show that municipalities counteract federal tax changes by raising their own taxes (partially) undoing federal tax changes. A higher degree of tax competition shifts the fiscal adjustment more to reduced public good spending. To provide empirical evidence for the theoretical predictions, I exploit cantonal variation in income tax policy across 19 Swiss cantons and find

that, municipalities in treatment cantons increase their own taxes and reduce public expenditure and investment. Municipalities more exposed to tax competition put more focus on investment and expenditure than taxation.

This paper studies the effect of salient fiscal rules on public institutions. To retrieve the causal effect of salience on tax setting behavior and the soundness of local public accounts, we exploit both across- and within-variation in the visibility of reference rates in the German Lander’s fiscal equalization systems. We find that, more than the need to recover lagged data or interjurisdiction comparison, mathematical operations – mainly multiplications, averages, and rounding – are central determinants of non-salience. In turn, the inclusion of mathematical operations (especially if described in words without including a formula notation) leads to large errors in the tax setting strategies of municipalities which imposes significant and inefficient economic pressure on their finances.

In 1993, Finland transitioned from a global or comprehensive income tax to a dual income tax (DIT) system. An overlooked side-effect of the reform was the removal of capital income from the local income tax base. Since local income taxes are an important source of revenue for Finnish municipalities, the reform resulted in negative revenue shocks where capital was concentrated. In this paper, we examine the local response to the change in the tax base and the increase in after-tax inequality. We first analyse the fiscal policy response to greater grant dependence but reduced tax competition due to the removal of the most mobile part of the income tax base. Next, we evaluate how election turnout and voting patterns change in response to the reduced taxation of capital income recipients and the associated rise in inequality, using the loss of taxable income as a salience mechanism.