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Fiscal competition, revenue sharing, and policy-induced agglomeration

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  • HINDRIKS, Jean
  • PERALTA, Susana
  • WEBER, Shlomo

Abstract

Revenue sharing can be used to discourage low tax regions from competing for capital and firms with high tax regions. However, with heterogeneous regions, revenue sharing involves net transfers across regions and creates a 'moral-hazard' problem that is, regions may want to invest less in market fostering public good when the benefits are shared across nations. This paper analyzes these costs and benefits of revenue sharing. When asymmetric regions compete in capital income taxes only, we show that revenue sharing can be desirable for the high tax region if it is pushed far enough (i.e., J-curve effect), while tax harmonization is always harmful for the low tax region. When regions also compete through public investments, we find that tax competition distorts (downwards) public investments. While revenue sharing discourages public investments due to moral-hazard effect, it remains beneficial in most cases. Moreover, there are new agglomeration forces resulting from public investments, because the inflow of capital raises the incentive for public investments which in turn attract more capital. This leads to the possibility of policy-induced agglomeration (which is different from the classical agglomeration forces in the New Economic geography).

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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2005093.

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Date of creation: 00 Jan 2005
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Handle: RePEc:cor:louvco:2005093

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Keywords: heterogeneous regions; fiscal federalism; revenue sharing; moral hazard; agglomeration;

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References

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  1. Jean Hindriks & Gareth D. Myles, 2000. "Strategic Inter-Regional Transfers," Working Papers 417, Queen Mary, University of London, School of Economics and Finance.
  2. FIGUIÈRES, Charles & HINDRIKS, Jean & MYLES, Gareth D., . "Revenue sharing versus expenditure sharing in a federal system," CORE Discussion Papers RP -1683, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. Marko Köthenbürger, 2002. "Tax Competition and Fiscal Equalization," International Tax and Public Finance, Springer, vol. 9(4), pages 391-408, August.
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  6. FIGUIÈRES, Charles & HINDRIKS, Jean & MYLES, Gareth D., 2001. "Revenue sharing versus expenditure sharing," CORE Discussion Papers 2001015, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  7. Kanbur, Ravi & Keen, Michael, 1993. "Jeux Sans Frontieres: Tax Competition and Tax Coordination When Countries Differ in Size," American Economic Review, American Economic Association, vol. 83(4), pages 877-92, September.
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Citations

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Cited by:
  1. Zemanek, Holger, 2009. "Fiscal Transfers and Structural Reforms in the European Monetary Union," MPRA Paper 19357, University Library of Munich, Germany.
  2. Carl Gaigné & Stéphane Riou, 2007. "Globalization, Asymmetric Tax Competition, and Fiscal Equalization," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(5), pages 901-925, October.
  3. C. Dembour, 2008. "Competition for Business Location: A Survey," Journal of Industry, Competition and Trade, Springer, vol. 8(2), pages 89-111, June.

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