(essentially) the costs of the factors of production employed by a business appears to be a potentially promising path to pursue, particularly in more urbanized areas.<sup>84</sup> The question is how to realize the potential virtues of local business taxation – essentially an elastic revenue source and increased autonomy – while minimizing such problems as economic distortions, high administrative costs, and breaking the “correspondence principle” by permitting local governments to ‘export’ (non-benefit) taxes to non-residents. One way to achieve this aim is to impose what has been called a ‘business value tax’ (BVT).<sup>85</sup> Businesses add value by combining labor and capital with other purchased inputs. The value added by labor is the cost of labor (wages and salaries) while the value added by capital is the cost of capital (both debt and equity). The tax base would consist of revenues less purchases of inputs (except labor). From an administrative perspective, such a tax base could be calculated in three different ways. The first is simply to add back appropriate amounts of interest and wages to the base of a business income tax as usually calculated. A second approach is to impose both a payroll tax and an appropriate tax on capital. The third and probably the easiest approach in most countries is to impose the tax on essentially the same base as a value-added tax.

Compared to a conventional value-added tax (VAT), however, a BVT has three important distinguishing features. First, it is a tax on income, not consumption: that is, it is imposed on profits as well as wages or, to put it another way, on investment as well as consumption. Second, as a tax on production, rather than consumption, it is imposed on an origin rather than a destination basis, and thus in effect taxes exports but not imports. A third distinction is administrative: the tax would be assessed on the basis of accounting records (or equivalent estimates) rather than on a transaction basis and collected annually (or by periodic payments based on an annual assessment.

While taxing investment and exports may not at first appear to be a very good idea, such a tax actually has several important advantages as a form of subnational business tax, especially compared to the various forms of such taxes now existing in most countries. To begin with, it discriminates less against investment than do income or property taxes. Moreover, because of its broader base rates can be lower so that economic distortion costs (which roughly rise as the square of the tax rate) will also be lower than with other business taxes that yield the same revenue. In addition, the revenues from a BVT will be more stable than taxes on income or profits, thus providing a more secure revenue base for subnational government. At the same time, since a BVT is more responsive to changed economic conditions than property taxes it will give subnational governments more incentive to encourage economic growth. Moreover, to the extent the rationale for taxing business at the local level rests on benefit or entitlement grounds, a BVT is arguably a more equitable way to tax business than a tax on income or profits. Finally, the broad base of the BVT may make it more resistant to base erosion and “tax games” than either income or property taxes. This last characteristic would be strengthened if subnational governments were restricted to imposing only a single uniform rate on all forms of business.

> 84 In small rural areas, however, as a rule, the only fiscal basis acceptable to local governments in such cases is some form of tax based on property.(Bird and Slack 2008): see also the broader discussion of rural finance in Kitchen and Slack (2006).

> 85 This concept was introduced in Bird and Mintz (2000) and spelled out for Canada in Bird and Mckenzie (2001) and for developing countries in  Bird (2003).