The impact of tax sharing agreements on local fiscal policy: Evidence from the Fonds des Frontaliers Luxembourgeois
Abstract
This paper examines how a tax revenue sharing scheme between Belgium and Luxembourg changed local fiscal policy in the border region. A large share of Luxembourg’s labour force consists of commuters living in Belgium. According to the countries’ double tax treaty, the income of cross-border commuters is taxed only in the state of source. As a result, also Belgian municipalities are prevented from levying income taxes, a main source of municipal revenue. In compensation however, the “Fonds des Frontaliers” was established in 2004.
To determine whether the resulting grants to Belgian municipalities internalized the fiscal externality and supported growth in the region, this paper utilized detailed data on municipal accounts and commuting flows. The identification strategy exploits the introduction as well as a reform of the fund and encompasses a range of differencein-differences analyses comparing compensated municipalities to similar control municipalities.
Preliminary results suggest the fund succeeded in internalizing externalities by reducing tax pressure on non-commuters and supporting investment in transport infrastructure while shoring up the capacity of public administration, education and social services.
