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Vertical Versus Horizontal Tax Externalities: An Empirical Test

  • Marius BRÜLHART
  • Mario JAMETTI

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 suboptimally 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 data set 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.

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Paper provided by Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 04.11.

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Length: 41 pages
Date of creation: Jul 2004
Date of revision:
Handle: RePEc:lau:crdeep:04.11
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Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne

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