Discussion paper

DP6512 Does Tax Competition Tame the Leviathan?

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.

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Citation

Brülhart, M and M Jametti (eds) (2007), “DP6512 Does Tax Competition Tame the Leviathan?”, CEPR Press Discussion Paper No. 6512. https://cepr.org/publications/dp6512