Fiscal Decentralization with Distortionary Taxation: Tiebout vs. Tax Competition

This paper explores a question that lies at the intersection of two vast literatures. The goal is to gauge whether the good side of fiscal decentralization, as emphasized by the Tiebout literature, dominates the bad side, as studied in the tax-competition literature. The results, which are derived by numerical simulation, show that either answer to this question is possible. Under favorable conditions, where the curvature of the production function and the dispersion of preferences are both high, the gains from Tiebout sorting are likely to outweigh the loss from the capital-tax distortion, so that the good side of fiscal decentralization dominates. If either of these conditions is absent, however, the bad side can win, making decentralization undesirable. When this happens, the lessons of the Tiebout tradition are overturned, with economic efficiency requiring centralized rather than decentralized provision of public goods.

[1]  G. Tabellini,et al.  Federal Fiscal Constitutions: Risk Sharing and Redistribution , 1996, Journal of Political Economy.

[2]  Clubs as a case of competitive industry with goods of variable quality , 1980 .

[3]  Kangoh Lee.  Uncertain income and redistribution in a federal system , 1998 .

[4]  T. Ter-Minassian.  Fiscal Federalism in Theory and Practice , 1997 .

[5]  S. Bucovetsky.  Asymmetric tax competition , 1991 .

[6]  E. Berglas,et al.  On the Theory of Clubs , 1976 .

[7]  William H. Hoyt,et al.  Property taxation, Nash equilibrium, and market power , 1991 .

[8]  Henry Tulkens,et al.  Commodity Tax Competition Between Member States of a Federation , 1986 .

[9]  John D. Wilson,et al.  A theory of interregional tax competition , 1986 .

[10]  A. Alesina,et al.  On the Number and Size of Nations , 1995 .

[11]  John D. Wilson.  Mobile Labor, Multiple Tax Instruments, and Tax Competition , 1995 .

[12]  John D. Wilson,et al.  Tax competition with interregional differences in factor endowments , 1991 .

[13]  W. Hoyt.  Competitive jurisdictions, congestion, and the Henry George Theorem: When should property be taxed instead of land? , 1991 .

[14]  Boundary optima and the theory of public goods supply , 1988 .

[15]  M. Wooders.  Equilibria, the core, and jurisdiction structures in economies with a local public good , 1978 .

[16]  J. Henderson.  The Tiebout Model: Bring Back the Entrepreneurs , 1985, Journal of Political Economy.

[17]  Stephen Coate,et al.  Centralized Versus Decentralized Provision of Local Public Goods: a Political Economy Analysis , 1999 .

[18]  M. Wooders,et al.  Competitive equilibrium and the core in club economies with anonymous crowding , 1987 .

[19]  Peter M. Mieszkowski,et al.  Pigou, Tiebout, Property Taxation, and the Underprovision of Local Public Goods , 1986, Taxation in Theory and Practice.

[20]  John D. Wilson.  Property taxation, congestion, and local public goods , 1997 .

[21]  J. Litvack.  Rethinking Decentralization in Developing Countries , 1998 .

[22]  Mark V. Pauly,et al.  Income redistribution as a local public good , 1973 .

[23]  B. Pleskovic.  Annual World Bank Conference on Development Economics 1997 , 1999 .

[24]  J. Henderson.  Community choice of revenue instruments , 1994 .

[25]  D. Wildasin,et al.  Interjurisdictional Capital Mobility: Fiscal Externality and a Corrective Subsidy , 1989 .

[26]  J. Henderson.  Will homeowners impose property taxes , 1995 .

[27]  G. Tabellini,et al.  Federal Fiscal Constitutions: Risk Sharing and Moral Hazard , 1996 .

[28]  J. Brueckner.  A Tiebout/tax-competition model , 2000 .

[29]  Charles M. Tiebout.  A Pure Theory of Local Expenditures , 1956, Journal of Political Economy.

[30]  P. Pestieau,et al.  Tax Competition and Revelation of Preferences for Public Expenditure , 1998 .

[31]  W. Oates,et al.  Assistance to the Poor in a Federal System , 1985 .

[32]  D. Wildasin.  Income Redistribution in a Common Labor Market , 1991 .

[33]  D. Wildasin.  Nash equilibria in models of fiscal competition , 1988 .

[34]  Tore Ellingsen.  Externalities vs internalities: a model of political integration , 1998 .

[35]  John D. Wilson.  Theories of Tax Competition , 1999, National Tax Journal.

[36]  D. Pinés,et al.  CLUBS, LOCAL PUBLIC GOODS AND TRANSPORTATION MODELS A synthesis , 1981 .

[37]  Jacques-François Thisse,et al.  On the Optimal Structure of Local Governments , 1995 .

[38]  Thomas Romer,et al.  Mobility and Redistribution , 1991, Journal of Political Economy.