Strategic Tax Cuts: How Central and Local Governments Respond to Political Incentives

Abstract This study examines how political opportunism in local governments varies based on fiscal decision-making authority—whether controlled by the central government or left to local discretion. We propose two theoretical mechanisms—the political business cycle hypothesis and the electoral competition hypothesis—and test them in the context of government tax cuts. Using South Korea’s institutional setting, where both central and local governments can implement tax cuts, we analyze how political opportunism differs across governance levels. Our findings show strong support for the political business cycle hypothesis when the central government determines tax cuts, with tax reductions increasing as elections approach. However, electoral competition does not influence central government tax policy, likely due to uniform national policies. In contrast, local governments exhibit heterogeneity—political opportunism is more pronounced in electorally competitive districts. These results suggest that local fiscal autonomy can either constrain or amplify political opportunism, depending on electoral incentives.