International Tax and Public Finance

, Volume 17, Issue 1, pp 1–14 | Cite as

Federal tax competition and the efficiency consequences for local taxation of revenue equalization

  • Christos Kotsogiannis


Recent work has shown that a system of equalization grants can neutralize the efficiency loss caused by tax competition among lower-level governments. These models, however, ignore the vertical tax externalities that occur when the federal and lower-level governments levy taxes on the same base. This paper incorporates equalization grants into a standard capital tax competition model in which there are horizontal tax externalities between jurisdictions and vertical tax externalities between the levels of government. It is shown that, even in the presence of vertical tax externalities, an efficient level of lower-level government taxation can be achieved with a modifying version of a standard equalization grant formula.


Federal tax competition Fiscal externalities Equalization grants 

JEL Classification

H41 H71 H77 


Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.


  1. Boadway, R., & Keen, M. J. (1996). Efficiency and the optimal direction of federal-state transfers. International Tax and Public Finance, 3, 137–155. CrossRefGoogle Scholar
  2. Boadway, R., Marchand, M., & Vigneault, M. (1998). The consequences of overlapping tax bases for redistribution and public spending in a federation. Journal of Public Economics, 68, 453–478. CrossRefGoogle Scholar
  3. Bucovetsky, S., & Smart, M. (2006). The efficiency consequences of local revenue equalization: tax competition and tax distortions. Journal of Public Economic Theory, 8, 119–144. CrossRefGoogle Scholar
  4. Büttner, T. (2006). The incentive effect of fiscal equalization transfers on tax policy. Journal of Public Economics, 90, 477–497. CrossRefGoogle Scholar
  5. Büttner, T., Hauptmeier, S., & Schwager, R. (2006). Efficient revenue sharing and upper level governments: Theory and application to Germany. Mimeo, Goettingen University. Google Scholar
  6. Cassing, J. H., & Hillman, A. L. (1982). State-federal resource tax rivalry: The Queensland railway and the federal export tax. Economic Record, 58, 235–241. CrossRefGoogle Scholar
  7. Dahlby, B. (1994). The distortionary effect of rising taxes. In W. Robson & W. Scarth (Eds.), Deficit Reduction: What Pain, What Gain? (pp. 44–72). Toronto: C.D. Howe Institute. Google Scholar
  8. Dahlby, B. (1996). Fiscal externalities and the design of intergovernmental grants. International Tax and Public Finance, 3, 397–412. CrossRefGoogle Scholar
  9. Dahlby, B. (2008, forthcoming). The marginal cost of public funds: Theory and applications. Cambridge: MIT Press. Google Scholar
  10. Dahlby, B., & Wilson, S. (2003). Vertical fiscal externalities in a federation. Journal of Public Economics, 87, 917–930. CrossRefGoogle Scholar
  11. DePater, J., & Myers, G. (1994). Strategic capital tax competition: A pecuniary externality and a corrective device. Journal of Urban Economics, 36, 66–78. CrossRefGoogle Scholar
  12. Devereux, M., Lockwood, B., & Redoano, M. (2007). Horizontal and vertical indirect tax competition: Theory and evidence from the USA. Journal of Public Economics, 91, 451–479. CrossRefGoogle Scholar
  13. Flowers, M. R. (1988). Shared tax sources in a Leviathan model of federalism. Public Finance Quarterly, 16, 67–77. Google Scholar
  14. Johnson, W. R. (1988). Income redistribution in a federal system. American Economic Review, 78, 570–573. Google Scholar
  15. Hoyt, W. H. (1991). Property taxation, Nash equilibrium and market power. Journal of Urban Economics, 30, 123–131. CrossRefGoogle Scholar
  16. Karakosta, O., & Kotsogiannis, C. (2006). Imperfect competition, principles of commodity taxation and tax inefficiencies in federal systems. Mimeo, University of Exeter. Google Scholar
  17. Karkalakos, S., & Kotsogiannis, C. (2007). A spatial analysis of provincial income tax responses: Evidence from Canada. Canadian Journal of Economics, 40, 782–811. Google Scholar
  18. Keen, M. (1998). Vertical tax externalities in the theory of fiscal federalism. IMF Staff Papers, 45, 454–485. Google Scholar
  19. Keen, M. J., & Kotsogiannis, C. (2002). Does federalism lead to excessively high taxes? American Economic Review, 93, 363–370. CrossRefGoogle Scholar
  20. Keen, M. J., & Marchand, M. (1997). Fiscal competition and the pattern of public spending. Journal of Public Economics, 66, 33–53. CrossRefGoogle Scholar
  21. Köthenbürger, M. (2002). Tax competition and fiscal equalization. International Tax and Public Finance, 9, 391–408. CrossRefGoogle Scholar
  22. Kotsogiannis, C., & Schwager, R. (2008, forthcoming). Accountability and fiscal equalization. Journal of Public Economics. Google Scholar
  23. Rizzo, L. (2008). Local government responsiveness to federal transfers: theory and evidence. International Tax and Public Finance, 15, 316–337. CrossRefGoogle Scholar
  24. Smart, M. (1998). Tax and deadweight loss in a system of intergovernmental transfers. Canadian Journal of Economics, 31, 189–206. CrossRefGoogle Scholar
  25. Smart, M. (2007). Raising taxes through equalization. Canadian Journal of Economics, 40, 1188–1212. Google Scholar
  26. Wildasin, D. (1989). Interjurisdictional capital mobility: Fiscal externality and a corrective subsidy. Journal of Urban Economics, 25, 193–212. CrossRefGoogle Scholar
  27. Wilson, J. D. (1986). A theory of interregional tax competition. Journal of Urban Economics, 19, 296–315. CrossRefGoogle Scholar
  28. Wilson, J. D. (1999). Theories of tax competition. National Tax Journal, LII, 269–304. Google Scholar
  29. Wrede, M. (1996). Vertical and horizontal tax competition: Will uncoordinated Leviathans end up on the wrong side of the Laffer curve? Finanzarchiv, 53, 461–479. Google Scholar
  30. Wrede, M. (2000). Shared tax sources and public expenditure. International Tax and Public Finance, 7, 163–175. CrossRefGoogle Scholar
  31. Zodrow, G., & Mieszkowski, P. (1986). Pigou, property taxation and the underprovision of local public goods. Journal of Urban Economics, 19, 356–370. CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2008

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of Exeter Business School, Streatham Court, Rennes DriveExeterUK

Personalised recommendations