This paper investigates how tourism taxes are used by municipalities to attract tourists. We analyze how municipalities compete among each other, explicitly accounting for the spatial dimension. This paper provides a novel contribution to the literature on tax competition by explicitly modeling and testing the spatial dimension. First, we present a spatial model of tax competition, which is an adoption of the Hotelling model of imperfect competition in the linear city. We find that tax rates are strategic complements, as a change in taxes of one town will lead to a similar change of tax rates in neighboring towns. Second, we test the model with data from tourism taxes along the Italian coastline. We find that towns on the Tyrrhenian coast loose tourists to municipalities in the (south) east, if those reduce their tourism tax rate, and compete by lowering their own tax rates with respect to towns in the (north) west. We do not find similar behavior along the Adriatic coast.
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