Abstract
This paper analyzes the impact of fiscal equalization on asymmetric tax competition when positive agglomeration externalities are present. It uses a model focusing on the strategic reason for capital taxes to demonstrate that per capita fiscal capacity equalization improves the spatial allocation of capital provided a sufficiently rich (marginally) larger region and sufficiently strong agglomeration externalities. If tax revenue is used to finance public goods, per capita fiscal capacity equalization generally cannot simultaneously eliminate public good inefficiency and spatial inefficiency. However, the achievement of full efficiency for ex ante identical regions requires excessive (full) equalization in the presence (absence) of agglomeration externalities.
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Notes
Clearly, in contrast to the NEG model, the real-agglomeration model has nothing to offer with respect to trade integration.
A somewhat similar model is used by Boadway et al. (2004).
This is standard in trade theory, see, e.g., Choi and Yu (2002). In regional economics, the mobile input is usually considered as source of agglomeration externalities (see, e.g., Fujita and Thisse 2002). However, as long as the “internal” production function is Cobb–Douglas, both approaches yield the same results.
Partial derivatives are indicated by subscripts.
Krogstrup (2008) analyzes the core-periphery outcome implied by F KK (K,N)>0.
Assuming a fixed aggregate capital stock simplifies the analysis. If capital supply were elastic, the equalization scheme must take the elasticities of capital supply and demand into account (see, Bucovetsky and Smart 2006).
It is assumed that these conditions are also sufficient.
Note that, according to Eq. (13), in a symmetric equilibrium, the subsidy goes to infinity if α goes to 1. Furthermore, close to full equalization would have substantial redistributive effects at the expense of workers.
This section simply assumes that a unique Nash equilibrium of tax competition exists. In numerical simulations, an equilibrium exists even if α=1.
These conditions are sufficient but not necessary. To equalize marginal products of capital, the equalization scheme may correct for inefficient public good supply.
The rather complex formula for an asymmetric equilibrium with equalization is not shown.
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Acknowledgements
A previous version of the paper was presented at PET 2009, at the annual conference of the Verein für Socialpolitik 2009, at a research seminar at the Barcelona Institute of Economics (IEB). Participant comments are appreciated. I have also greatly benefited from the comments of the co-editor of this journal, Eckhard Janeba, and two anonymous reviewers.
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Wrede, M. Agglomeration, tax competition, and fiscal equalization. Int Tax Public Finance 21, 1012–1027 (2014). https://doi.org/10.1007/s10797-013-9295-7
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DOI: https://doi.org/10.1007/s10797-013-9295-7