A fistful of dollars: Rent seeking behaviour and local tax manipulation

The aim of this paper is to study whether politicians manipulate tax policy to extract private rents. We focus on the local personal income tax in the setting of Italian cities, which is a progressive instrument that allows mayors to set different rates to distinct wage groups. We exploit discontinuities in mayors' salaries, that are based on population thresholds, to study whether mayors apply lower rates to their own tax bracket, thereby distorting tax policy. The main results document large rent-seeking activity in tax policy. First, we show that when mayors's salary is exogenously located in the following tax bracket it receives a significantly lower tax rate than the previous one, compared to the control group. Second, we show that this rent-seeking activity is highly detrimental for the public treasury, with a considerable reduction in fiscal revenues. And finally, we document that the individual gain for rent-seeker politicians is rather limited and that there is no evidence of voters' punishment in the next elections. These results suggest that when tax policy is prone to be manipulated politicians do not hesitate to engage in rent-seeking activities even in case of little returns.