We develop a model of Tiebout sorting based on decentralized income taxation, which allows for spillovers and imperfect rivalry in consumption of the publicly provided good. We identify three sources of welfare loss from decentralization: Imperfect redistribution, inter-jurisdictional free-riding, and inefficient residential choice. Whereas the welfare loss from imperfect redistribution decreases and that from free-riding rises unambiguously as the publicly provided good becomes more pure, the welfare loss from the inefficient residential choice depends non-monotonically on spillovers and rivalry. The equilibrium can be characterized by relative crowding of either the rich or the poor municipality. Our results imply that the characteristics of the publicly provided good are an important determinant for the welfare costs of decentralization.

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This paper develops a model of Tiebout sorting with decentrally determined progressive income taxation and a built-in fiscal equalization scheme that redistributes money from richer to poorer regions. Both aspects are central to policy makers: the progressivity for equity reasons and the fiscal equalization to prevent an underprovision of the publicly provided good and to limit the degree of segregation of households according to income. The model is calibrated to the metropolitan area of Zurich (Switzerland), and policy evaluations reveal that a progressive tax scheme as the basis for decentrally determined tax rates causes strong segregating forces that can only to some extent be compensated by the fiscal equalization scheme.