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Tax competition in federations and the welfare consequences of decentralization

Author

Listed:
  • Michael J. Keen

    (International Monetary Fund)

  • Christos Kotsogiannis

    (Department of Economics, University of Exeter)

Abstract

This paper explores the impact of intensified tax competition within federal systems characterized by the presence of both horizontal tax externalities between the states and vertical tax externalities between states and federal government. It shows that although these point in opposite directions (horizontal towards state taxes that are too low, vertical towards state taxes that are too high), leaving the net outcome unclear, intensified tax competition always worsens their combined effect. That is, intensified lower-level tax competition—in the form of an increase in the number of lower-level jurisdictions—is sure to reduce welfare, but this is not because, as usually supposed, it makes excessively low state taxes even lower; rather, it is welfare-reducing either for that reason or because it makes excessively high state taxes even higher.

Suggested Citation

  • Michael J. Keen & Christos Kotsogiannis, 2002. "Tax competition in federations and the welfare consequences of decentralization," Discussion Papers 0201, University of Exeter, Department of Economics.
    • Handle: RePEc:exe:wpaper:0201
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    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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