Using a spatial equilibrium model, we show that high local productivity enables rent-seeking governments to extract rent from taxpayers by reducing residents’ out-migration response to local tax hikes. This is supported by the empirical finding that tax burden and public-private wage gap tend to be higher in more productive cities and states. To distinguish government rent-seeking from other mechanisms, we analyze variations in public-sector collective bargaining legality across states and local governments’ revenue dependence on state governments. We demonstrate that government rent-seeking creates spatial misallocation, discouraging workers from choosing high-productivity locations. Our quantitative model indicates that eliminating rent-seeking motives in state and local taxes can increase national output, although both the productivity and welfare gains are moderated by spatial differences in housing supply constraints.