Working Paper: CEPR ID: DP4593
Authors: Marius Brülhart; Mario Jametti
Abstract: 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.
Keywords: fiscal federalism; horizontal externalities; Swiss tax system; tax competition; vertical externalities
JEL Codes: H10; H21; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| smaller municipalities (H70) | higher tax rates (H29) |
| cantonal tax indices (H25) | municipal tax rates (H71) |
| fragmentation of federations (H77) | tax rates (H29) |