Economics Letters 45 (1994) 391-395 0165-1765/94/$07.00 0 1994 Elsevier Science B.V. All rights reserved 391 The impact of taxes on the privatization zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Robert A. McGuire* zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Department of Economics, University Robert L. Ohsfeldt of municipal services of Akron, Akron, OH 44325, USA University of Alabama at Birmingham, Birmingham, AL, USA Received 17 August 1993 Final revision received 1 February 1994 Accepted 7 February 1994 zyxwvutsrqponmlkjihgfedcbaZYXWVUTSRQPONMLKJIHGFEDCBA Abstract Municipal governments incur a cost of privatization through taxes paid to other governments by private contractors producing municipal services. Empirical analysis finds lower tax costs do not increase privatization of school transportation. JEL class$cation: L33 1. Introduction An extensive literature comparing the performance of private production with public (not-for- profit) production generally concludes that private, for-profit producers are more efficient than their public counterparts [e.g. De Alessi (1980) and Boardman and Vining (1989)]. Yet the coexistence of private and public production persists for many publicly financed services - especially municipal services. Recently, several explanations for the choice of private or public production of publicly funded services have been offered. De Alessi (1982) and Borcherding (1983) conjecture that differential monitoring costs and redistributional objectives might explain the private/public mix, but neither provides supporting empirical evidence. Other studies provide empirical evidence that the private/public mix is affected by differences in features of private and public sector labor markets, such as unionization [McGuire et al. (1987, 1990), Stein (1990), Chandler and Feuille (1991)], and differences in voter preferences for private or public production [McGuire et al. (1987, 1990)]. Holcombe (1990) argues that federal and state governments create ‘tax costs’ to local governments that privatize public production because private firms pay taxes, whereas local governments are tax exempt. He conjectures that changes in tax costs created by federal tax reforms during the 1980s might explain changes in the private/public mix. ’ In this paper we extend the literature by examining the impact of state and local taxes on a local government’s choice of private or public production. If there is a tax cost of privatization, * Corresponding author. ’ Holcombe (1990) provides simulations to suggest how federal tax changes increased the tax cost of privatization after 1986. However, state government taxes are not examined nor is any empirical evidence presented on actual changes in the level of privatization during the 1980s. SSDI 0165-1765(93)00435-5