Ad-valorem taxation and the balance of externalities in federations

Vertical Fiscal Externalities and Federal Tax-Transfers under Variable Factor Supplies

“…Previous studies using models with one factor of production in variable supply, conclude that with speci…c taxes and under centralized leadership, resulting to negative vertical …scal externality, the federal government sets a negative speci…c tax on the rate of return to the factor in variable supply, which can lead to bottom-up transfers, e.g., among others Boadway and Keen (1996). Subsequent studies demonstrate that with ad valorem taxation the above results can be reversed if the demand for the factor in variable supply is inelastic, e.g., Kotsogiannis and Martinez (2008), Karakosta (2010), and Sas (2017). We revisit these results in the case of variable labor and capital supplies and speci…c factor taxes.…”

“…This analysis serves as a benchmark case to the alternative equilibrium setting of capital taxes by both levels of government, to be examined later on. 17 Di¤erentiating the federal welfare function W = N u with respect to the capital tax , treating labor taxes exogenous, and using equations (1), (2) and (6) we obtain: 18 1…”

“…1 A pivotal conclusion of the relevant literature which considers models with a single factor in variable supply is that when tax-bases are shared among di¤erent tiers of government, and tax rates are speci…c, the emerging vertical …scal externalities are negative, implying ine¢ ciently high non-cooperative speci…c taxes, e.g., Boadway and Keen (1996), Keen (1998), Boadway et al (1998), Hoyt (2001), Keen andKotsogiannis (2002, 2004), Köthenbürger (2004), and Boadway and Tremblay (2012). 2 With ad valorem taxes, however, the vertical …scal externality can be either positive or negative, e.g., Dahlby and Wilson (2003), Kotsogiannis and Martinez (2008), Karakosta (2010), and Sas (2017). 3 1 Vertical …scal externalities di¤er from horizontal …scal externalities, the latter is due to the tax competition among state governments which results to horizontal mobility of tax-bases among them, e.g., Bucovetsky and Wilson (1991), Wilson and Wildasin (2004), Ogawa et al (2016).…”