Tax Interactions with Asymmetric Information and Nonlinear Instruments

When different layers of government exert their taxing power upon a common base, the decisions made by one tier affect the receipts that the other policymakers can collect. Likewise, when same level authorities derive their receipts from a mobile tax base, a competition mechanism takes place that triggers externalities. This paper proposes a model where both horizontal and vertical interactions take place. Uncertainty concerning the base, that is, the amount of capital likely to be invested, is introduced and a generalization of taxation schemes is provided through the choice of the instruments, in order to assess the robustness of traditional analyses results in a more general and realistic scheme. With respect to a unique government framework, an excessively high level of taxation emerges from the simultaneous interplay of horizontal and vertical tax externalities.