This research provides the first rigorous evidence on the presence, significance, nature and impact of strategic fiscal interactions among local governments in Colombia. Using spatial panel data for most municipalities for the period 2000--09, the studies find that, when setting their own tax rates, municipal governments take into account the tax rates of the adjacent municipalities. These strategic interactions are synchronous and occur in both property and business taxation. Contrary to tax competition theory, however, the empirical analysis indicates that the property and ICA tax bases are not sensitive to tax rate differentials among municipalities, pointing to the absence of cut-throat competition that leads to suboptimal tax rates in a race-to-the-bottom process. Instead, analysis of popularity for three municipal elections between 2000 and 2007 shows that property tax differentials across municipalities affect local election results, signaling the presence of yardstick competition in this source; specifically, while increases in own property tax rates have adverse effects on vote shares for the main party in the municipal council, increases in tax rates of adjacent municipalities have a favorable impact. Such patterns are not present in ICA taxation. Overall, the findings suggest that tax competition is not a major concern in Colombia, and that some form of yardstick competition is the likely source of the observed strategic tax interaction among municipalities. In addition, the research finds adverse effects of strategic property tax interactions on student performance and infant mortality. Strategic interaction among neighboring municipalities leading to lower taxation levels likely drives this negative result. Conversely, strategic interaction in setting ICA tax rates does not seem to affect education and health outcomes.;The evidence from this research suggests that traditional policies to lessen local tax competition, such as tax harmonization, tighter central government controls and supervision, and equalization grants, may not be justified and, if implemented, are likely to be ineffective. The results also suggest that effective actions to improve the outcomes from decentralization and local strategic interaction likely require the design and implementation of policy measures that help to improve local government accountability. Future research is needed on the political motivations underlying imitation in tax setting policy and the extent of competition arising from input provision, expenditures and land use regulation and policy.
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