On Defaults, Framing, and Local Tax Policy: Quasi-Experimental Evidence from Portugal

We find that policy decisions made by elected politicians in Portuguese municipalities violate the predictions of standard microeconomic theory. Municipalities can choose a withholding rate between zero and five percent of the income tax revenue collected within their boundaries by the national tax authority. A reform altered the withholding rate applicable if a municipality fails to communicate its chosen rate to the national tax authority, reducing it from five to zero percent. According to standard microeconomic theory, this reform leaves a municipality’s decision problem unchanged. In municipalities with strong electoral competition, however, right-leaning mayors choose significantly lower rates than their left-leaning counterparts after the reform. Adopting a behavioral perspective, we argue that the reform influenced perceptions and resulted in increased electoral accountability, especially in municipalities with intense electoral competition. Politicians in these municipalities responded by adjusting withholding rates to better align with their constituents’ (ideological) preferences.