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Revenue Decentralization, The Local Income Tax Deduction, And The Provision Of Public Goods

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  • Hatfield, John William
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    Abstract

    We consider a model where local and national governments invest in both productive and consumptive public goods using income tax revenue. Local governments will overprovide the consumptive public good if the local income tax is (fully or partially) deductible. However, without full deductibility, local governments will underprovide local productive public goods. Hence, to reduce the distortions in local governments’ decisions, a welfare-maximizing national government will underinvest in both types of public goods, assuming that the level of national public good provision does not directly affect the local governments’ decisions. We also consider an alternative fiscal structure where the national government sets one national tax rate and provides matching grants for expenditures on productive public goods; this can result in efficient levels of public good provision at both the local and national levels.

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    Bibliographic Info

    Article provided by National Tax Association in its journal National Tax Journal.

    Volume (Year): 66 (2013)
    Issue (Month): 1 (March)
    Pages: 97-115

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    Handle: RePEc:ntj:journl:v:66:y:2013:i:1:p:97-115

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    1. Feldstein, Martin S & Metcalf, Gilbert E, 1987. "The Effect of Federal Tax Deductibility on State and Local Taxes and Spending," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(4), pages 710-36, August.
    2. Michael Keen, 1998. "Vertical Tax Externalities in the Theory of Fiscal Federalism," IMF Staff Papers, Palgrave Macmillan, Palgrave Macmillan, vol. 45(3), pages 454-485, September.
    3. Dahlby, Bev & Wilson, Leonard S., 2003. "Vertical fiscal externalities in a federation," Journal of Public Economics, Elsevier, Elsevier, vol. 87(5-6), pages 917-930, May.
    4. Michael J. Keen & Christos Kotsogiannis, 2002. "Does Federalism Lead to Excessively High Taxes?," American Economic Review, American Economic Association, American Economic Association, vol. 92(1), pages 363-370, March.
    5. Gordon, Roger H, 1983. "An Optimal Taxation Approach to Fiscal Federalism," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 98(4), pages 567-86, November.
    6. Hoyt, William H., 2001. "Tax Policy Coordination, Vertical Externalities, and Optimal Taxation in a System of Hierarchical Governments," Journal of Urban Economics, Elsevier, vol. 50(3), pages 491-516, November.
    7. Cassing, J H & Hillman, A L, 1982. "State-Federal Resource Tax Rivalry: The Queensland Railway and the Federal Export Tax," The Economic Record, The Economic Society of Australia, The Economic Society of Australia, vol. 58(162), pages 235-41, September.
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