The consequences of overlapping tax bases for redistribution and public spending in a federation

Abstract

Tax and expenditure policies are studied in a federation with imperfectly mobile households. States implement a linear progressive tax and supply a public good. A vertical scal externality, re ecting the e ect of state policies on federal revenues, provides an incentive for state taxes to be too progressive. A horizontal scal externality causes non-optimal states taxes and expenditures because of the migration e ect. The federal government implements its own linear progressive tax and makes transfers to the states. The federal government can nullify both externalities by appropriate scal policies, and redistributive taxation can be decentralized to the states.

Who do you blame in local finance? An analysis of municipal financing in Italy

“…The possible inefficiency arising from more levels of government insisting on the same tax base has already been stressed by the literature on vertical tax externalities (e.g. Keen, 1998;Boadway et al, 1998), but the political effect in terms of a possible reduction of accountability for local governments has been less discussed (but see Cabral and Hoxby, 2012 and Norregaard, 2013 for similar insights). On theoretical grounds, version of our own idea have already been proposed (Besley, 2007) and applied to different outcomes such as the observability of government reporting procedures (Milesi-Ferretti, 2000), government's choice between taxes and debt (Alt and Dreyer Lassen, 2003), the hidden financing of interest groups (Coate and Morris, 1995), the trade off between accountability and efficiency (Bordignon and Minelli, 2001), and the political economic budget cycle (Rogoff et al 1988), among others.…”

Vertical income tax externalities and fiscal interdependence: evidence from the US

“…More recently, Wagoner (1995), Wrede (1996), Boadway and Keen (1996), Dalhby (1996), Boadway et al (1997), and Sato (1997) have also addressed this issue.…”

Vertical Tax Externalities in the Theory of Fiscal Federalism

“…They also have implications, for example, for distributional policy: Johnson (1988) and Boadway, Marchand, and Vigneault (1998) point out that vertical externalities may induce the states to undertake too much redistribution, perceiving part of the revenue cost to be passed on to the federal government and thereby to other states. Nor has the discussion covered all of the vertical externalities that can arise in federations.…”