The Efficiency Consequences of Local Revenue Equalization: Tax Competition and Tax Distortions

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. This paper shows how a popular system of federal revenue equalization grants can limit tax competition among subnational governments, correct fiscal externalities, and increase government spending. Remarkably, an equalization grant can implement efficient policy choices by regional governments, regardless of a wide variety of differences in regional tax capacity, tastes for public spending, and population. Thus, compared to other corrective devices, equalization achieves "robust" implementation. If aggregate tax bases are elastic, however, equalization leads to excessive taxation. Efficiency can be achieved by a modified formula that equalizes a fraction of local revenue deficiencies equal to the fraction of taxes that are shifted backward to factor suppliers. JEL Classification: H7. Terms of use: Documents in EconStor may

The incentive effect of fiscal equalization transfers on tax policy

“…This would restore efficiency, if coordinated capital taxation were non-distortive. Of course, as emphasized by Bucovetsky and Smart (2002), it is generally not the case that full equalization is efficient.…”

“…Standard models of tax competition argue that in a decentralized setting the mobility of the tax base will tend to increase the marginal cost of raising public funds for each individual jurisdiction with adverse consequences for the supply of public services. Since redistributive fiscal transfers might have the opposite impact on the marginal cost of raising public funds, recent theoretical research suggests that a redistributive system of interjurisdictional transfers might help to restore efficiency in an otherwise inefficient equilibrium of tax competition (Bucovetsky andSmart, 2002, Koethenbuerger, 2002). …”

Do politicians reward core supporters? Evidence from a discretionary grant program

“…See Bucovetsky and Smart (2006), Buettner (2006 and2009), Buettner and Wildasin (2006), and Smart (2007) We exclude outliers from our analysis: 14 municipalities that had negative average project grants because they had to repay grants and four municipalities that had project grants of above 800 euros per capita. For one municipality with only 11 inhabitants the election results are not available due to election secrecy.…”

Efficient Revenue Sharing and Upper Level Governments: Theory and Application to Germany

“…As emphasized in the tax competition literature this may lead to inefficiently low taxes due to the existence of fiscal externalities of local tax policy decisions (e.g., Wilson, 1999). However, many countries with a decentralized public sector also display some redistributive grant systems which tend to internalize fiscal externalities arising from tax competition (Bucovetsky andSmart, 2002, Köthenbürger, 2002).…”

“…More specifically, we consider a standard model of tax competition between local jurisdictions and follow Bucovetsky and Smart (2002) by introducing a system of redistributive grants enforced by the state level which under certain assumptions restores efficiency. This setting is then extended by introducing additional government objectives at the state level, such that the state government is not solely interested in the efficiency of local finances but also aims at pursuing own policies under its specific constraints.…”