Abstract
Higher wages in agglomerations often do not reflect an increase in purchasing power, because a high percentage of the wage increase has to be spend on housing. Thus, after housing is considered taxpayers may have identical disposable incomes, although gross as well as after-tax income may differ. This unequal treatment of taxpayers is due to the taxation of nominal incomes. If tax systems taxed income based on regionally adjusted purchasing power, horizontal equity would be assured. Since this is an unfeasible option, the differences could be corrected by allowing a deduction on housing costs. Given the large revenue losses, it seems unlikely that governments in OECD countries move to a system where rents are deductible in determining taxable income. Another alternative—taxation of potentially achievable income—is unfeasible due to political opposition. A final and less costly alternative is fiscal federalism. Granting autonomy to the lower levels of the government offers local governments the power to design the tax system in a way that reflects differences in living costs. Although this option does not necessarily imply that governments effectively design the tax schedule in that way, a comparison of Germany and Switzerland shows that governments are aware of these differences across regions. The paper concludes that granting tax autonomy to the lower tiers in Germany would make many citizens, especially in the Southern part, better off and would promote horizontal equity among German taxpayers.
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Notes
Besides these attempts that compare a given structure of the political system, some analyses have focused on the endogenous formation of federal structures (e.g. Frey and Eichenberger 1996).
The discussion of regional horizontal equity is not unique to the tax system. The same issues discussed in this paper also arise in the case where (unemployed) individuals receive identical social welfare cash payments and the (regionally varying) housing rent is paid by the state.
Major reforms, which pushed Germany’s federal structure away from a system of competitive federalism, while increasing cooperative mechanisms as well as the veto power of the German Laender, occurred in 1955 and 1969 (for a discussion: Döring and Schnellenbach 2011).
The focus on housing in this paper is motivated for two reasons: First, some expenditure items (e.g. postal services; supermarket purchases; clothing) do not exhibit large regional price variations; second although other goods share also regional price fluctuations (e.g. restaurant visits) housing costs should be the dominant expenditure category in a households budget.
Of course at the expense of citizens in other regions if the revenue constraint is binding.
Such a conclusion rests on the assumption that the right indicator to measure ability to pay is income (instead of wealth or consumption).
One exception within Switzerland is the canton Zug who offers a housing cost deduction.
Whereas the principle of horizontal equity is (implicitly) acknowledged in an international context, it has been most times neglected within a country. For example, the OECD’s “Taxing wages” publication (2016) does not compare the tax burden across member states by focusing on a hypothetical income (of for example 100,000 Euro). The reason why the OECD does not pursue such an approach are the large income differences across member states. Instead, it compares the tax burden by utilizing country-specific average incomes (alternatively: 67% or 167% of average earnings). Although differences in public and private goods matter across regions within a country, these differences should be even more pronounced in an international context.
An additional assumption is that individual 2 consumes a larger amount of his/her income, since housing costs are lower than the housing costs of individual 1.
Zurich, Geneva, Basel, Lausanne, Bern, Lucerne and St. Galle.
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Acknowledgements
I thank Martin Daepp, Bruno Jeitziner, Alowin Moes, Mario Morger, Simon Schnyder, one anonymous referee and the editor for useful suggestions. The opinions, findings and conclusions expressed in this paper are those of the author and do not necessarily reflect the views of the Swiss Federal Department of Finance. All remaining errors are mine.
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Schwarz, P. Federalism and horizontal equity across Switzerland and Germany: a new rationale for a decentralized fiscal structure. Const Polit Econ 28, 97–116 (2017). https://doi.org/10.1007/s10602-017-9234-1
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DOI: https://doi.org/10.1007/s10602-017-9234-1