The negative effects of ethnic diversity on fiscal performance have been pointed out in several studies. These weaknesses are attributed to the lack of trust between ethnic groups, own-group bias in the willingness to support public expenditure, and a tendency to avoid, or evade, taxes when a feeling of injustice is prevalent - both within the majority group and among disadvantaged minorities. But, if ethnic diversity is bad for public policy, will a Tiebout (1956) type ethnic segregation lead to better performance? In this paper we show that, at least with respect to municipalities inhabited by a disadvantaged minority, the costs of segregation could be quite substantial. We examine one fiscal performance indicator in the local authorities in Israel: local taxes collected in each locality as a share of tax charges imposed by that locality. We find that this collection rate is substantially lower in Arab localities, than in Jewish ones, even after accounting for differences in socio-economic indicators and in various variables that affect tax exemptions and discounts. These findings are in line with those of studies in psychology, social work and education that point out low motivation and self-efficacy of discriminated minorities, which are reflected in inefficient - and sometimes destructive - behaviors.

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