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Vertical versus horizontal tax externalities: An empirical test

  • Brulhart, Marius
  • Jametti, Mario

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 suboptimally 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 measurable variables. This test is applied to a panel data set 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.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 90 (2006)
Issue (Month): 10-11 (November)
Pages: 2027-2062

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Handle: RePEc:eee:pubeco:v:90:y:2006:i:10-11:p:2027-2062
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