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A Second-Best Theory of Local Government Policy

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  • Dietmar Wellisch
  • Jorg Hülshorst

Abstract

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

Suggested Citation

  • Dietmar Wellisch & Jorg Hülshorst, 2000. "A Second-Best Theory of Local Government Policy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 7(1), pages 5-22, February.
  • Handle: RePEc:kap:itaxpf:v:7:y:2000:i:1:p:5-22
    DOI: 10.1023/A:1008749628237
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    File URL: http://hdl.handle.net/10.1023/A:1008749628237
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    References listed on IDEAS

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    1. Wildasin, David E, 1984. "On Public Good Provision with Distortionary Taxation," Economic Inquiry, Western Economic Association International, vol. 22(2), pages 227-243, April.
    2. Dietmar Wellisch, 1995. "Can household mobility solve basic environmental problems?," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 2(2), pages 245-260, August.
    3. Browning, Edgar K, 1976. "The Marginal Cost of Public Funds," Journal of Political Economy, University of Chicago Press, vol. 84(2), pages 283-298, April.
    4. 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.
    5. 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.
    6. 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.
    7. Wilson, John Douglas, 1991. "Optimal Public Good Provision with Limited Lump-Sum Taxation," American Economic Review, American Economic Association, vol. 81(1), pages 153-166, March.
    8. Henderson, J. Vernon, 1994. "Community choice of revenue instruments," Regional Science and Urban Economics, Elsevier, vol. 24(2), pages 159-183, April.
    9. A. B. Atkinson & N. H. Stern, 1974. "Pigou, Taxation and Public Goods," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 119-128.
    10. Roger H. Gordon, 1983. "An Optimal Taxation Approach to Fiscal Federalism," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 567-586.
    11. Brueckner, Jan K., 1983. "Property value maximization and public sector efficiency," Journal of Urban Economics, Elsevier, vol. 14(1), pages 1-15, July.
    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. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
    14. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416-416.
    15. 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 113-133, January.
    16. Slemrod, Joel, 1990. "Optimal Taxation and Optimal Tax Systems," Journal of Economic Perspectives, American Economic Association, vol. 4(1), pages 157-178, Winter.
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    Cited by:

    1. Robert Philipowski, 2017. "Locational efficiency in a federal system without land rent taxation," Review of Regional Research: Jahrbuch für Regionalwissenschaft, Springer;Gesellschaft für Regionalforschung (GfR), vol. 37(1), pages 91-102, February.
    2. Oates, Wallace E., 2001. "Fiscal competition and European Union: contrasting perspectives," Regional Science and Urban Economics, Elsevier, vol. 31(2-3), pages 133-145, April.
    3. Soldatos, Gerasimos T., 2014. "Local Taxation, Private-Public Consumption Complementarity, and the Optimal Number of Jurisdictions," MPRA Paper 60861, University Library of Munich, Germany.
    4. Fuest Clemens & Riphahn Regina, 2001. "Is the Local Business Tax a User Tax? An Empirical Investigation for Germany / Ist die Gewerbesteuer eine Äquivalenzsteuer? Eine empirische Analyse für Deutschland," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 221(1), pages 14-31, February.

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    Keywords

    optimal taxation; local government finance;

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