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

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  • Willem Sas

    (KU Leuven)

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.

Suggested Citation

  • Willem Sas, 2017. "Can fiscal equalisation mitigate tax competition? Ad valorem and residence-based taxation in a federation," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 24(5), pages 817-853, September.
    • Handle: RePEc:kap:itaxpf:v:24:y:2017:i:5:d:10.1007_s10797-016-9435-y
    DOI: 10.1007/s10797-016-9435-y
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    2. Ana B. Ania & Andreas Wagener, 2021. "Laboratory federalism with public funds sharing," Economic Inquiry, Western Economic Association International, vol. 59(3), pages 1047-1065, July.
    3. Mutsumi Matsumoto & Hikaru Ogawa, 2022. "Tax Competition and Efficient Fiscal Transfers under Capital and Labor Income Taxes," CIRJE F-Series CIRJE-F-1196, CIRJE, Faculty of Economics, University of Tokyo.
    4. Shiou-Yen Chu & Tsaur-Chin Wu, 2023. "Ad valorem versus unit taxes on capital in a dynamic stochastic general equilibrium model," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 30(6), pages 1435-1456, December.
    5. Mutsumi Matsumoto & Hikaru Ogawa, 2023. "Corporate income tax competition and efficient tax base equalization," Economics of Governance, Springer, vol. 24(1), pages 109-118, March.
    6. Ana B. Ania & Andreas Wagener, 2021. "Laboratory federalism with public funds sharing," Economic Inquiry, Western Economic Association International, vol. 59(3), pages 1047-1065, July.

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    More about this item

    Keywords

    Tax competition; Ad valorem taxation; Vertical and horizontal externalities; Fiscal equalisation; Residence-based taxation; Fiscal federalism;
    All these keywords.

    JEL classification:

    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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