The Relationship Between Local Tax Price and Demand of the Public Goods

In this study, we use a structural demand framework rather than simple correlations between taxes and expenditure to investigate whether local taxes in Korea function as a price mechanism for local public goods. We construct a panel dataset for 226 basic local governments (cities, counties, and autonomous districts) over the period 2000–2017 and estimate local public expenditure equations separately for each group. To capture both long-run relationships and short-run dynamics while addressing nonstationarity and endogeneity, we combine fully modified ordinary least squares, panel error-correction models, and system generalized method of moments. Across these specifications, local tax burdens—especially when measured as the ratio of per capita local tax to total general expenditure—are generally negatively associated with local expenditure. However, we show that this negative association is distinct from the price elasticity of demand implied by the structural model: the relevant elasticities, derived from the estimated coefficients rather than observed directly, remain positive for cities, counties, and districts. The results indicate that, under Korea’s current intergovernmental fiscal arrangements, local taxes do not operate as a conventional price signal that induces residents to demand less of local public goods when tax price increases. These findings suggest that transfer dependence, limited fiscal autonomy, and rigid expenditure responsibilities weaken the price mechanism of local taxes and have important implications for the design of local tax policy and intergovernmental fiscal equalization.