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Local government responsiveness to federal transfers: theory and evidence

  • Leonzio Rizzo

    ()

Federal transfers can depend on local fiscal capacity which is measured by local tax bases. The aim of this paper is to understand to what extent and how these transfers affect local tax decisions. We develop a model with two provinces producing one mobile good. The good is taxed according to the destination principle. Final consumers decide to buy the good from the province where it is cheaper. The two provinces engage in tax competition. The introduction of scale economies into the shopping technology generates nonlinear tax reaction functions which make it possible to test the effect of a transfer equalizing local tax bases on tax competition in two complementary tax regimes. Used for this purpose are cigarette and gasoline tax data from Canada. In the case of cigarette tax it is found that nonlinearity in tax competition is almost entirely offset when equalization holds: tax competition in the two tax regimes become closer. The shopping technology for gasoline gives less scope for scale economies, so that equalization does not affect reaction functions.

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File URL: http://hdl.handle.net/10.1007/s10797-007-9025-0
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Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 15 (2008)
Issue (Month): 3 (June)
Pages: 316-337

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Handle: RePEc:kap:itaxpf:v:15:y:2008:i:3:p:316-337
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  1. Tim Besley & Harvey S. Rosen, 1997. "Vertical externalities in tax settings: evidence from gasoline and cigarettes," IFS Working Papers W97/23, Institute for Fiscal Studies.
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  4. Mintz, Jack & Tulkens, Henry, 1986. "Commodity tax competition between member states of a federation: equilibrium and efficiency," Journal of Public Economics, Elsevier, vol. 29(2), pages 133-172, March.
  5. Sam Bucovetsky & Michael Smart, 2002. "The Efficiency Consequences of Local Revenue Equalization: Tax Competition and Tax Distortions," CESifo Working Paper Series 767, CESifo Group Munich.
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  15. Jan K. Brueckner & Luz A. Saavedra, 2000. "Do Local Governments Engage in Strategic Property-Tax Competition?," Econometric Society World Congress 2000 Contributed Papers 0357, Econometric Society.
  16. Devereux, Michael P. & Lockwood, Ben & Redoano, Michela, 2002. "Do Countries Compete over Corporate Tax Rates?," CEPR Discussion Papers 3400, C.E.P.R. Discussion Papers.
  17. Marko Köthenbürger, 2002. "Tax Competition and Fiscal Equalization," International Tax and Public Finance, Springer, vol. 9(4), pages 391-408, August.
  18. Sotiris Karkalakos & Christos Kotsogiannis, 2007. "A spatial analysis of provincial corporate income tax responses: evidence from Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 40(3), pages 782-811, August.
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