Working Paper: CEPR ID: DP6512
Authors: Marius Brülhart; Mario Jametti
Abstract: 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.
Keywords: tax competition; optimal taxation; government preferences; fiscal federalism; direct democracy
JEL Codes: D7; H2; H7
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax competition (H26) | equilibrium taxes (H29) |
| Size of jurisdictions (H73) | equilibrium tax rates (H29) |
| Type of government (H10) | equilibrium tax rates (H29) |
| Direct democracy (D72) | government behavior (H10) |
| Tax competition (H26) | tax rates (H29) |
| Fragmentation (F12) | tax rates (H29) |
| Tax competition (H26) | welfare (I38) |