DP4593 Vertical versus Horizontal Tax Externalities: An Empirical Test
|Author(s):||Marius Brülhart, Mario Jametti|
|Publication Date:||September 2004|
|Keyword(s):||fiscal federalism, horizontal externalities, Swiss tax system, tax competition, vertical externalities|
|JEL(s):||H10, H21, H25|
|Programme Areas:||Public Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4593|
We study taxation externalities in federations of benevolent governments. Where different hierarchical government levels tax the same base, one can observe two types of externalities: a horizontal externality, working among governments of the same level and leading to tax rates that are too low compared to the social optimum; and a vertical externality, working between different levels of government and leading to sub-optimally high tax rates. Building on the model of Keen and Kotsogiannis (2002), we derive a discriminating hypothesis to distinguish vertical and horizontal tax externalities based on observable variables. This test is applied to a panel dataset on local taxes in a sample of Swiss municipalities that feature direct-democratic fiscal decision making, so as to maximize the correspondence with the benevolent.governments of the theory. We find that vertical externalities dominate - they are thus an observed empirical phenomenon as well as a notable extension to the theory of tax competition.