International Tax and Public Finance

, Volume 24, Issue 5, pp 817–853 | Cite as

Can fiscal equalisation mitigate tax competition? Ad valorem and residence-based taxation in a federation

Article
  • 322 Downloads

Abstract

In this paper, we revisit the combined effect of horizontal and vertical tax externalities in a federal context, extending the theoretical framework of Keen and Kotsogiannis (Am Econ Rev 92(1):363–370, 2002) by allowing for ad valorem and residence-based taxation. When taxes are levied ad valorem rather than per-unit firstly, we find the interaction between both types of externalities is more ambiguous than commonly understood. As a result, and contrary to earlier findings, fiscal equalisation mechanisms such as the representative transfer system (RTS) fail to fully internalise the tax externalities. Given these limitations, we derive the conditions under which a standard RTS will either: (1) at least nudge politicians in the right direction; (2) realise no welfare gains at all; (3) considerably overshoot the second-best efficiency mark causing welfare loss. Lastly, we find that when taxation is residence-based rather than source-based, a different kind of competition emerges where tax cuts are aimed at stimulating outward factor flows, rather than attracting inward flows.

Keywords

Tax competition Ad valorem taxation Vertical and horizontal externalities Fiscal equalisation Residence-based taxation Fiscal federalism 

JEL Classification

H71 H77 H23 

Notes

Acknowledgements

This is a revised version of a chapter of my PhD dissertation. I gratefully thank Thomas Aronsson, Robin Boadway, Thiess Buettner, André Decoster, Susana Peralta, Stef Proost, Albert Solé-Ollé, two anonymous referees and participants at the IIPF Annual Conference in Dublin, the ERSA Annual conference in Lisbon, the Halle Colloquy on Local Public Finance, the ZEW conference on fiscal equalisation in Mannheim, and the 15th Journées Louis-André Gerard-Varet in Aix-en-Provence for very helpful comments and suggestions to this or an earlier version of the paper. The financial support of BELSPO (Contract TA/00/39) and the ‘Steunpunt beleidsrelevant Onderzoek Fiscaliteit en Begroting’ (2011–2015) is also much appreciated. The usual disclaimer applies.

References

  1. Aiura, H., & Ogawa, H. (2013). Unit tax versus ad valorem tax: A tax competition model with cross-border shopping. Journal of Public Economics, 105, 30–38.CrossRefGoogle Scholar
  2. Akai, N., Ogawa, H., & Ogawa, Y. (2011). Endogenous choice on tax instruments in a tax competition model: Unit tax versus ad valorem tax. International Tax and Public Finance, 18(5), 495–506.CrossRefGoogle Scholar
  3. Albouy, D. (2012). Evaluating the efficiency and equity of federal fiscal equalization. Journal of Public Economics, 96(9), 824–839.CrossRefGoogle Scholar
  4. Andersson, L., Aronsson, T., & Wikström, M. (2004). Testing for vertical fiscal externalities. International Tax and Public Finance, 11(3), 243–263.CrossRefGoogle Scholar
  5. Aronsson, T., & Blomquist, S. (2008). Redistribution and provision of public goods in an economic federation. Journal of Public Economic Theory, 10(1), 125–143.CrossRefGoogle Scholar
  6. Aronsson, T., & Wikström, M. (2003). Optimal taxation and risk-sharing arrangements in an economic federation. Oxford Economic Papers, 55(1), 104–120.CrossRefGoogle Scholar
  7. Atkinson, A. B., & Stern, N. H. (1974). Pigou, taxation and public goods. The Review of economic studies, 41(1), 119–128.Google Scholar
  8. Bird, R. M., & Tarasov, A. V. (2004). Closing the gap: Fiscal imbalances and intergovernmental transfers in developed federations. Environment and Planning C: Government and Policy, 22(1), 77–102.CrossRefGoogle Scholar
  9. Bizioli, G., & Sacchetto, C. (2011). Tax aspects of fiscal federalism: A comparative analysis. Amsterdam: IBFD.Google Scholar
  10. Boadway, R., & Keen, M. (1996). Efficiency and the optimal direction of federal-state transfers. International Tax and Public Finance, 3(2), 137–155.CrossRefGoogle Scholar
  11. Boadway, R., & Shah, A. (2009). Fiscal federalism: Principles and practice of multiorder governance. Cambridge: Cambridge University Press.CrossRefGoogle Scholar
  12. Boadway, R., & Tremblay, J.-F. (2006). A theory of fiscal imbalance. FinanzArchiv: Public Finance Analysis, 62(1), 1–27.CrossRefGoogle Scholar
  13. Boadway, R. W., & Shah, A. (2007). Intergovernmental fiscal transfers: Principles and practices. Washington, DC: World Bank Publications.Google Scholar
  14. Brueckner, J. K. (2003). Strategic interaction among governments: An overview of empirical studies. International Regional Science Review, 26(2), 175–188.CrossRefGoogle Scholar
  15. Brülhart, M., & Jametti, M. (2006). Vertical versus horizontal tax externalities: An empirical test. Journal of Public Economics, 90(10), 2027–2062.CrossRefGoogle Scholar
  16. 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
  17. Buettner, T. (2006). The incentive effect of fiscal equalization transfers on tax policy. Journal of Public Economics, 90(3), 477–497.CrossRefGoogle Scholar
  18. Dahlby, B. (1996). Fiscal externalities and the design of intergovernmental grants. International Tax and Public Finance, 3(3), 397–412.CrossRefGoogle Scholar
  19. Dahlby, B. (2008). The marginal cost of public funds: Theory and applications. Cambridge, MA: MIT Press Books. 1.CrossRefGoogle Scholar
  20. Dahlby, B., Mintz, J., & Wilson, S. (2000). The deductibility of provincial business taxes in a federation with vertical fiscal externalities. Canadian Journal of Economics/Revue canadienne d’économique, 33(3), 677–694.CrossRefGoogle Scholar
  21. Dahlby, B., & Wilson, L. S. (2003). Vertical fiscal externalities in a federation. Journal of Public Economics, 87(5–6), 917–930.CrossRefGoogle Scholar
  22. De Borger, B., Dunkerley, F., & Proost, S. (2007). Strategic investment and pricing decisions in a congested transport corridor. Journal of Urban Economics, 62(2), 294–316.CrossRefGoogle Scholar
  23. Devereux, M. P., Lockwood, B., & Redoano, M. (2007). Horizontal and vertical indirect tax competition: Theory and some evidence from the USA. Journal of Public Economics, 91(3), 451–479.CrossRefGoogle Scholar
  24. Egger, P., Koethenbuerger, M., & Smart, M. (2010). Do fiscal transfers alleviate business tax competition? Evidence from Germany. Journal of Public Economics, 94(3), 235–246.CrossRefGoogle Scholar
  25. Esteller-Moré, A., Galmarini, U., & Rizzo, L. (2016). Fiscal equalization and lobbying. International Tax and Public Finance, 1–27.Google Scholar
  26. Esteller-Moré, Á., & Solé-Ollé, A. (2001). Vertical income tax externalities and fiscal interdependence: Evidence from the US. Regional Science and Urban Economics, 31(2), 247–272.CrossRefGoogle Scholar
  27. Esteller-Moré, A., & Solé-Ollé, A. (2002). Tax setting in a federal system: The case of personal income taxation in Canada. International Tax and Public Finance, 9(3), 235–257.CrossRefGoogle Scholar
  28. Ferede, E. (2016). The incentive effects of equalization grants on tax policy evidence from Canadian provinces. Public Finance Review, 1–25.Google Scholar
  29. Goodspeed, T. J. (2000). Tax structure in a federation. Journal of Public Economics, 75(3), 493–506.CrossRefGoogle Scholar
  30. Goodspeed, T. J. (2002). Tax competition and tax structure in open federal economies: Evidence from OECD countries with implications for the European union. European Economic Review, 46(2), 357–374.CrossRefGoogle Scholar
  31. Hindriks, J., Peralta, S., & Weber, S. (2008). Competing in taxes and investment under fiscal equalization. Journal of Public Economics, 92(12), 2392–2402.CrossRefGoogle Scholar
  32. Hoffmann, M., & Runkel, M. (2016). A welfare comparison of ad valorem and unit tax regimes. International Tax and Public Finance, 23(1), 140–157.CrossRefGoogle Scholar
  33. Keane, M., & Rogerson, R. (2012). Micro and macro labor supply elasticities: A reassessment of conventional wisdom. Journal of Economic Literature, 50(2), 464–476.CrossRefGoogle Scholar
  34. Keen, M. (1998). Vertical tax externalities in the theory of fiscal federalism. Staff Papers, 45(3), 454–485.CrossRefGoogle Scholar
  35. Keen, M., & Marchand, M. (1997). Fiscal competition and the pattern of public spending. Journal of Public Economics, 66(1), 33–53.CrossRefGoogle Scholar
  36. Keen, M. J., & Kotsogiannis, C. (2002). Does federalism lead to excessively high taxes? The American Economic Review, 92(1), 363–370.CrossRefGoogle Scholar
  37. Keen, M. J., & Kotsogiannis, C. (2004). Tax competition in federations and the welfare consequences of decentralization. Journal of Urban Economics, 56(3), 397–407.CrossRefGoogle Scholar
  38. Köthenbürger, M. (2002). Tax competition and fiscal equalization. International Tax and Public Finance, 9(4), 391–408.CrossRefGoogle Scholar
  39. Kotsogiannis, C. (2010). Federal tax competition and the efficiency consequences for local taxation of revenue equalization. International Tax and Public Finance, 17(1), 1–14.CrossRefGoogle Scholar
  40. Kotsogiannis, C., & Martinez, D. (2008). Ad valorem taxes and the fiscal gap in federations. Economics Letters, 99(3), 431–434.CrossRefGoogle Scholar
  41. Krelove, R. (1992). Efficient tax exporting. Canadian Journal of Economics, 25(1), 145–155.Google Scholar
  42. Lichter, A., Peichl, A., & Siegloch, S. (2015). The own-wage elasticity of labor demand: A meta-regression analysis. European Economic Review, 80, 94–119.CrossRefGoogle Scholar
  43. Liebig, T., & Sousa-Poza, A. (2006). The influence of taxes on migration: Evidence from Switzerland. Cambridge Journal of Economics, 30(2), 235–252.CrossRefGoogle Scholar
  44. Lockwood, B. (2004). Competition in unit vs. ad valorem taxes. International Tax and Public Finance, 11(6), 763–772.CrossRefGoogle Scholar
  45. Lucas, V. (2004). Cross-border shopping in a federal economy. Regional Science and Urban Economics, 34(4), 365–385.CrossRefGoogle Scholar
  46. McLure, C. E. (1967). The interstate exporting of state and local taxes: Estimates for 1962. National Tax Journal, 20(1), 49–77.Google Scholar
  47. Ogawa, H., & Wang, W. (2016). Asymmetric tax competition and fiscal equalization in a repeated game setting. International Review of Economics & Finance, 41, 1–10.CrossRefGoogle Scholar
  48. Persyn, D., & Torfs, W. (2015). A gravity equation for commuting with an application to estimating regional border effects in Belgium. Journal of Economic Geography, pages 1–21.Google Scholar
  49. Sato, M. (2000). Fiscal externalities and efficient transfers in a federation. International Tax and Public Finance, 7(2), 119–139.CrossRefGoogle Scholar
  50. Smart, M. (2007). Raising taxes through equalization. Canadian Journal of Economics/Revue canadienne d’économique, 40(4), 1188–1212.CrossRefGoogle Scholar
  51. Van der Haegen, H., Van Hecke, E., & Savenberg, S. (2000). Belgians on the move. population distribution from a historical and modern perspective. Belgeo. Revue belge de géographie, (1-2-3-4):173–188.Google Scholar
  52. Wilson, J. D. (1986). A theory of interregional tax competition. Journal of Urban Economics, 19(3), 296–315.CrossRefGoogle Scholar
  53. Wilson, J. D., & Janeba, E. (2005). Decentralization and international tax competition. Journal of Public Economics, 89(7), 1211–1229.CrossRefGoogle Scholar
  54. Zodrow, G. R., & Mieszkowski, P. (1986). Pigou, tiebout, property taxation, and the underprovision of 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.Department of EconomicsKU LeuvenLeuvenBelgium

Personalised recommendations