Advertisement

International Tax and Public Finance

, Volume 24, Issue 5, pp 800–816 | Cite as

Fiscal equalisation schemes under competition

  • Johannes BeckerEmail author
  • Michael Kriebel
Article
  • 468 Downloads

Abstract

This paper considers optimal fiscal equalisation in a federation that competes with other federations for business tax base. It formalises the argument that, under certain circumstances, federations have an incentive to foster tax competition among their subunits in order to attract tax base from other federations. We show that optimal fiscal equalisation serves the purpose of redistributing income from rich to poor subunits and of choosing an optimal level of tax competition. The latter is chosen as a trade-off between three goals. First, decentralised tax rate setting has positive fiscal externalities within the federation and, thus, tax rates are inefficiently low. Second, in the presence of hold-up problems in investment, tax rates may be inefficiently high. Then, tax competition serves as a commitment device for low future tax rates and is, thus, welfare enhancing. Third, generous fiscal equalisation within the federation is a commitment to not aggressively compete with subunits outside the federation for tax base; as a consequence, with optimal equalisation, equilibrium tax rates are higher within and outside the federation—and even higher than in the case of centralised (i.e. federal level) tax rate setting.

Keywords

Business taxation Fiscal equalisation Tax competition 

JEL Classification

H25 H32 H87 

Notes

Acknowledgements

We thank an anonymous referee as well as Monika Köppl-Turyna, Jens Malte Zoubek, Chikara Yamaguchi and participants at workshops and conferences in Dresden, Gent, Perth and Dublin for helpful comments. We are especially indebted to Thiess Büttner whose work on tax competition in the region around Frankfurt has inspired this paper. The usual disclaimer applies.

References

  1. Agrawal, D. (2016). Local fiscal competition: An application to sales taxation with multiple federations. Journal of Urban Economics, 91, 122–138.CrossRefGoogle Scholar
  2. Baretti, C., Huber, B., & Lichtblau, K. (2002). A tax on tax revenue: The incentive effects of equalizing transfers: Evidence from Germany. International Tax and Public Finance, 9(6), 631–649.CrossRefGoogle Scholar
  3. Becker, J., & Fuest, C. (2012). Transfer pricing policy and the intensity of tax rate competition. Economics Letters, 117(1), 146–148.CrossRefGoogle Scholar
  4. Becker, S., Egger, P., & Merlo, V. (2012). How low business tax rates attract MNE activity: Municipality-level evidence from Germany. Journal of Public Economics, 96(9–10), 698–711.CrossRefGoogle Scholar
  5. Besley, T., & Coate, S. (2003). Centralized versus decentralized provision of local public goods: A political economy approach. Journal of Public Economics, 81(12), 2611–2637.CrossRefGoogle Scholar
  6. Boadway, R. (2004). The theory and practice of equalization. CESifo Economic Studies, 50(1), 211–254.CrossRefGoogle Scholar
  7. Brennan, G., & Buchanan, J. (1980). The power to tax: Analytical foundations of a fiscal constitution. Cambridge: Cambridge University Press.Google Scholar
  8. Brueckner, J. K. (2004). Fiscal decentralization with distortionary taxation: Tiebout vs. tax competition. International Tax and Public Finance, 11(2), 133–153.CrossRefGoogle Scholar
  9. Bucovetsky, S., & Smart, M. (2006). The efficiency consequences of local revenue equalization: Tax competition and tax distortions. Journal of Public Economic Theory, 8(1), 119–144.CrossRefGoogle Scholar
  10. Büttner, T. (2001). Local business taxation and competition for capital: The choice of the tax rate. Regional Science and Urban Economics, 31(2–3), 215–245.CrossRefGoogle Scholar
  11. Büttner, T. (2003). Tax base effects and fiscal externalities of local capital taxation: Evidence from a panel of German jurisdictions. Journal of Urban Economics, 54(1), 110–128.CrossRefGoogle Scholar
  12. Büttner, T. (2006). The incentive effect of fiscal equalization transfers on tax policy. Journal of Public Economics, 90(3), 477–497.CrossRefGoogle Scholar
  13. Chen, D., & Mintz, J. M. (2013). 2013 Global Tax Competitiveness Ranking: Corporate tax policy at a crossroads. SPP Research Papers, 6(35), 1–35.Google Scholar
  14. Dahlby, B., & Warren, N. (2003). Fiscal incentive effects of the Australian equalisation system. Economic Record, 79(247), 434–445.CrossRefGoogle Scholar
  15. Devereux, M. P., Lockwood, B., & Redoano, M. (2008). Do countries compete over corporate tax rates? Journal of Public Economics, 92(5–6), 1210–1235.CrossRefGoogle Scholar
  16. Eaton, J., & Gersovitz, M. (1983). Country risk: Economic aspects. In R. J. Herring (Ed.), Managing international risk (pp. 75–108). Cambridge: Cambridge University Press.CrossRefGoogle Scholar
  17. Eaton, J., & Gersovitz, M. (1984). The theory of expropriation and deviations from perfect capital mobility. Economic Journal, 94(373), 16–40.CrossRefGoogle Scholar
  18. Egger, P., Köthenbürger, M., & Smart, M. (2010). Do fiscal transfers alleviate business tax competition? Evidence from Germany. Journal of Public Economics, 94(3–4), 235–246.CrossRefGoogle Scholar
  19. Grazzini, L., & Petretto, A. (2007). Tax competition between unitary and federal countries. Economics of Governance, 8(1), 17–36.CrossRefGoogle Scholar
  20. Hatfield, J. W., & Padró i Miquel, G. (2012). A political economy theory of partial decentralization. Journal of the European Economic Association, 10(3), 605–633.CrossRefGoogle Scholar
  21. Hayashi, M., & Boadway, R. (2001). An empirical analysis of intergovernmental tax interaction: The case of business income taxes in Canada. Canadian Journal of Economics, 34(2), 481–503.CrossRefGoogle Scholar
  22. von Hayek, F. A. (1948). Individualism and economic order. Chicago: University of Chicago Press.Google Scholar
  23. Hindricks, J., Peralta, S., & Weber, S. (2008). Competing in taxes and investment under fiscal equalization. Journal of Public Economics, 92(12), 2392–2402.CrossRefGoogle Scholar
  24. Janeba, E. (2000). Tax competition when governments lack commitment: Excess capacity as a countervailing threat. American Economic Review, 90(5), 1508–1519.CrossRefGoogle Scholar
  25. Janeba, E., & Wilson, J. D. (2011). Optimal fiscal federalism in the presence of tax competition. Journal of Public Economics, 95(11–12), 1302–1311.CrossRefGoogle Scholar
  26. Keen, M. J. (1998). Vertical tax externalities in the theory of fiscal federalism. Staff Papers (International Monetary Fund), 45(3), 454–485.CrossRefGoogle Scholar
  27. Keen, M., & Konrad, K. A. (2013). The theory of international tax competition and coordination. In A. J. Auerbach, R. Chetty, M. Feldstein, & E. Saez (Eds.) Handbook of Public Economics (Volume 5, pp. 257–328). Oxford: Newnes.Google Scholar
  28. Keen, M. J., & Kotsogiannis, C. (2002). Does federalism lead to excessively high taxes? American Economic Review, 92(1), 363–370.CrossRefGoogle Scholar
  29. Kehoe, P. J. (1989). Policy cooperation among benevolent governments may be undesirable. Review of Economic Studies, 56(2), 289–296.CrossRefGoogle Scholar
  30. Kessing, S. G., Konrad, K. A., & Kotsogiannis, C. (2009). Federalism, weak institutions and the competition for foreign direct investment. International Tax and Public Finance, 16(1), 105–123.CrossRefGoogle Scholar
  31. Keuschnigg, C., & Loretz, S. (2015). Steuerföderalismus–Eine fachliche Auseinandersetzung mit einem komplexen Thema. Innsbruck: Institut für F öderalismus.Google Scholar
  32. Konrad, K. A., & Lommerud, K. E. (2001). Foreign direct investment, intra-firm trade and ownership structure. European Economic Review, 45(3), 475–494.CrossRefGoogle Scholar
  33. Köthenbürger, M. (2002). Tax competition and fiscal equalization. International Tax and Public Finance, 9(4), 391–408.CrossRefGoogle Scholar
  34. Liesegang, C., & Runkel, M. (2016). Tax competition and fiscal equalization under corporate income taxation. CESifo Working Paper No. 6011.Google Scholar
  35. Oates, W. E. (1972). Fiscal federalism. New York: Harcourt Brace Jovanovich.Google Scholar
  36. Overesch, M., & Rincke, J. (2011). What drives corporate tax rates down? A reassessment of globalization, tax competition, and dynamic adjustment to shocks. Scandinavian Journal of Economics, 113(3), 579–602.Google Scholar
  37. Qian, Y., & Weingast, B. R. (1997). Federalism as a commitment to preserving market incentives. Journal of Economic Perspectives, 11(4), 83–92.CrossRefGoogle Scholar
  38. Schnitzer, M. (1999). Expropriation and control rights: A dynamic model of foreign direct investment. International Journal of Industrial Organization, 17(8), 1113–1137.CrossRefGoogle Scholar
  39. Schnitzer, M. (2002). Debt v. foreign direct investment: The impact of sovereign risk on the structure of international capital flows. Economica, 69(273), 41–67.CrossRefGoogle Scholar
  40. Smart, M. (2007). Raising taxes through equalization. Canadian Journal of Economics, 40(4), 1188–1212.CrossRefGoogle Scholar
  41. Thomas, J., & Worrall, T. (1994). Foreign direct investment and the risk of expropriation. Review of Economic Studies, 61(1), 81–108.CrossRefGoogle Scholar
  42. Weingast, B. R. (1995). The economic role of political institutions: Market-preserving federalism and economic development. Journal of Law, Economics and Organization, 11(1), 1–31.Google Scholar
  43. Wildasin, D. E. (1989). Interjurisdictional capital mobility: Fiscal externality and a corrective subsidy. Journal of Urban Economics, 25(2), 193–212.CrossRefGoogle Scholar
  44. Wilson, J. D., & Janeba, E. (2005). Decentralization and international tax competition. Journal of Public Economics, 89(7), 1211–1229.CrossRefGoogle Scholar
  45. Zodrow, G. R., & Mieszkowski, P. (1986). Pigou, local public goods. Journal of Urban Economics, 19(3), 356–370.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2017

Authors and Affiliations

  1. 1.University of MünsterMünsterGermany

Personalised recommendations