DP6512 Does Tax Competition Tame the Leviathan?
|Author(s):||Marius Brülhart, Mario Jametti|
|Publication Date:||October 2007|
|Keyword(s):||direct democracy, fiscal federalism, government preferences, optimal taxation, tax competition|
|JEL(s):||D7, H2, H7|
|Programme Areas:||Public Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6512|
We study the impact of tax competition on equilibrium taxes and welfare, focusing on the jurisdictional fragmentation of federations. In a representative-agent model of fiscal federalism, fragmentation among jurisdictions with benevolent tax-setting authorities unambiguously reduces welfare. If, however, tax-setting authorities pursue revenue maximization, fragmentation, by pushing down equilibrium tax rates, may under certain conditions increase citizen welfare. We exploit the highly decentralized and heterogeneous Swiss fiscal system as a laboratory for the estimation of these effects. While for purely direct-democratic jurisdictions (which we associate with benevolent tax setting) we find that tax rates increase in fragmentation, fragmentation has a moderating effect on the tax rates of jurisdictions with some degree of delegated government. Our results thereby support the view that tax competition can be second-best welfare enhancing by constraining the scope for public-sector revenue maximization.