New research finds that roughly a third of the annual tax burden that households escape by moving between two neighbouring Swiss municipalities with different local tax levels gets ''capitalised'' into higher annual rental costs.

The study by Christoph Basten, Maximilian von Ehrlich and Andrea Lassmann, which is published in the May 2017 issue of the Economic Journal, thus confirms that households do ''vote with their feet''. But because of ''frictions'', such as the costs of moving house or individual preferences for local public goods and services, they do so much less than the data would suggest at first sight.

The authors note that the phenomenon of households ''voting with their feet'' can encourage the efficient use of tax money. At the same time, tax differentials can induce the sorting of higher-income households into lower-tax municipalities, while lower-income and lower-skilled ones end up in higher-tax places (see the chart below).

Such sorting reinforces the need for some municipalities with a weaker tax base to charge higher tax rates. This provides a rationale for some transfers across municipalities, and is of key importance for the design of optimal tax policy.

The effect of tax rates on households ''voting with their feet'', as measured by differences in rents or house prices, is not trivial to identify empirically:

• First, jurisdictions with significantly different tax levels tend to differ also across many other dimensions, both political and, for example, geographical, climatic or logistical.

• Second, as higher-income households benefit relatively more from lower tax rates than lower-income households, low-tax jurisdictions are likely to attract relatively more high-income residents, which can trigger ''reverse causality'' from income levels (reflected in house prices) to tax rates.

The authors address these empirical challenges by comparing the prices and characteristics of pairs of residences that are located very close to each other and yet on different sides of the same segment of Swiss municipality borders. The main price-relevant differences within the pairs of residences in this geo-institutional setting are income tax burdens.

Furthermore, by focusing on variation in annual income tax burdens (rather than one-off property taxes) and measuring capitalisation by way of annual rental costs (rather than prices of one-off property acquisitions), the authors can gauge the elasticity of housing costs to tax burdens without having to assume any discount factors for property taxes or house prices.

At the same time, they exploit detailed socio-demographic data on the composition of residents in each small-scaled area to measure the extent of sorting of heterogeneous household types into municipalities that are levying different levels of income taxes.

''Income Taxes, Sorting, and the Costs of Housing: Evidence from Municipal Boundaries in Switzerland'', by Christoph Basten, Maximilian von Ehrlich and Andrea Lassmann is published in the May 2017 issue of the Economic Journal. Christoph Basten is at FINMA. Maximilian von Ehrlich is at the University of Bern. Andrea Lassmann is at the Swiss Federal Institute of Technology ETH Zurich.


These charts from the study illustrate the share of high- and low-skilled individuals at different km-distances from the border between a high- and a low-tax municipality. They show how right after crossing the border into the high-tax municipality, the share of high- or low-skilled (and correspondingly higher- or lower-income) individuals jumps up.