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A Second-Best Theory of Local Government Policy

  • Dietmar Wellisch
  • Jorg Hülshorst
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    This paper provides a model where a large number of small jurisdictions compete for mobile firms and households by supplying local public goods and factors. Jurisdictions only have an incomplete set of tax instruments at their disposal to achieve an efficient allocation. We derive second-best behavioral rules for local governments and extend optimal taxation results to the local level. Local governments distort locational decisions of mobile firms and households by taxing them above marginal congestion costs so as to balance relative locational distortions between taxes. The analysis also reveals that there is a systematic difference between the provision of local public goods and factors. While local public goods are provided according to the Samuelson rule in most situations considered, local public factors are undersupplied relative to this rule. Copyright Kluwer Academic Publishers 2000

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    Article provided by Springer in its journal International Tax and Public Finance.

    Volume (Year): 7 (2000)
    Issue (Month): 1 (February)
    Pages: 5-22

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    Handle: RePEc:kap:itaxpf:v:7:y:2000:i:1:p:5-22
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    1. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
    2. Skinner, Jonathan, 1991. "If Agricultural Land Taxation Is So Efficient, Why Is It So Rarely Used?," World Bank Economic Review, World Bank Group, vol. 5(1), pages 113-33, January.
    3. Gordon, Roger H, 1983. "An Optimal Taxation Approach to Fiscal Federalism," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 567-86, November.
    4. Wilson, John Douglas, 1991. "Optimal Public Good Provision with Limited Lump-Sum Taxation," American Economic Review, American Economic Association, vol. 81(1), pages 153-66, March.
    5. Joel Slemrod, 1989. "Optimal Taxation and Optimal Tax Systems," NBER Working Papers 3038, National Bureau of Economic Research, Inc.
    6. Browning, Edgar K, 1976. "The Marginal Cost of Public Funds," Journal of Political Economy, University of Chicago Press, vol. 84(2), pages 283-98, April.
    7. Brueckner, Jan K., 1983. "Property value maximization and public sector efficiency," Journal of Urban Economics, Elsevier, vol. 14(1), pages 1-15, July.
    8. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416.
    9. Dietmar Wellisch, 1995. "Can household mobility solve basic environmental problems?," International Tax and Public Finance, Springer, vol. 2(2), pages 245-260, August.
    10. Richter, Wolfram F. & Wellisch, Dietmar, 1996. "The provision of local public goods and factors in the presence of firm and household mobility," Journal of Public Economics, Elsevier, vol. 60(1), pages 73-93, April.
    11. Atkinson, Anthony B & Stern, N H, 1974. "Pigou, Taxation and Public Goods," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 119-28, January.
    12. Krelove, R., 1993. "The persistence and inefficiency of property tax finance of local public expenditures," Journal of Public Economics, Elsevier, vol. 51(3), pages 415-435, July.
    13. Wildasin, David E, 1984. "On Public Good Provision with Distortionary Taxation," Economic Inquiry, Western Economic Association International, vol. 22(2), pages 227-43, April.
    14. Henderson, J. Vernon, 1994. "Community choice of revenue instruments," Regional Science and Urban Economics, Elsevier, vol. 24(2), pages 159-183, April.
    15. Burbidge, John B. & Myers, Gordon M., 1994. "Population mobility and capital tax competition," Regional Science and Urban Economics, Elsevier, vol. 24(4), pages 441-459, August.
    16. Wellisch, Dietmar, 1994. "Interregional spillovers in the presence of perfect and imperfect household mobility," Journal of Public Economics, Elsevier, vol. 55(2), pages 167-184, October.
    17. Skinner, Jonathan, 1991. "Prospects for Agricultural Land Taxation in Developing Countries," World Bank Economic Review, World Bank Group, vol. 5(3), pages 493-511, September.
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