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Vertical versus Horizontal Tax Externalities: An Empirical Test

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  • Brülhart, Marius
  • Jametti, Mario

Abstract

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 sub-optimally 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 observable variables. This test is applied to a panel dataset 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.

Suggested Citation

  • Brülhart, Marius & Jametti, Mario, 2004. "Vertical versus Horizontal Tax Externalities: An Empirical Test," CEPR Discussion Papers 4593, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:4593
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    JEL classification:

    • H10 - Public Economics - - Structure and Scope of Government - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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