Optimal fiscal federalism in the presence of tax competition
This paper models the optimal division of public goods provision between central and regional governments in an economy with interregional tax competition. Regional provision is inefficient because governments compete for scarce capital by lowering their capital taxes and public good levels to inefficiently low levels. On the other hand, central provision is inefficient because it is determined by the minimum winning coalition within a legislature. The optimal degree to which public good provision should be decentralized depends on a tradeoff between these inefficiencies. In our main model, complete centralization is never optimal: regional governments should supply some public goods.
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