Fiscal Federalism, Spillovers And The Export Of Taxes

This paper ties together two recent important contributions to the analysis of fiscal federalism, namely when public goods spillovers and tax exportation exist simultaneously. In a two‐region analysis, with resources immobile, the analysis demonstrates that it may be to the advantage of a net tax ‘importing’ region to remain in a federation whenever the net tax ‘exporting’ region increases its production of a mutually beneficial good or service. Relaxing the assumption of resource immobility, the paper investigates the conditions in which a tax ‘importing’ region may find itself ‘better off’ than in the no tax ‘importation’ case. This paper also investigates standard notions of tax efficiency and illustrates that with tax exportation, previous notions of tax efficiency must be qualified. Furthermore, it is shown that due to tax distortions, it is possible for all parties to be made ‘better off’ through some form of tax harmonization, but it is to the advantage of no single region to correct its tax distortions.