Are agglomeration rents taxable in developing economies? Evidence from Colombia

Abstract

[Abstract] This paper examines whether Colombian municipalities endowed with stronger agglomeration economies, proxied by market potential, are able to sustain higher local business tax rates. Using cross sectional data for 1083 municipalities in 2022, we estimate a series of econometric specifications that control for fiscal capacity, geographic characteristics, and spatially correlated unobservables. The results point to a positive and robust association between market potential and local business tax rates, consistent with the presence of taxable agglomeration rents. Using a semi-parametric specification and a mixed geographically weighted regression we have also uncovered that the ‘local business tax rates market potential’ relationship is heterogeneous both across space and along the market potential distribution. From a policy perspective, these findings indicate that agglomeration forces may translate into asymmetric local tax capacity, thereby reinforcing existing territorial disparities in revenue-raising ability and public service provision.