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Yardstick Competition and Tax Competition -Intergovernmental Relations and Efficiency of Public Goods-

Author

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  • Yasuyuki Nishigaki

    (Ryukoku University)

  • Hideya Kato

    (Ryukoku University)

Abstract

Several branches of the literature focus on the advantages of the provision of public goods by a local government. Tiebout (1956) indicated that ?voting with feet? leads to the optimal provision of local public goods if residents can emigrate from one municipality to another to maximize utility. Due to the free mobility of residents, local governments exhibit an inter-related performance in a competitive environment and are disciplined to achieve efficient provision of public goods, although rather unrealistic conditions, including perfect information and ?free mobility? of residents, are pre-requested.The theory of local yardstick competition, in the principal?agent setting with asymmetric information, states that the comparison of the public service level and tax rates of a government with that of nearby localities can provide a useful instrument to assess a government?s performance. By comparing the performance of similar jurisdictions, voters can elect good politicians and send non-performers packing. Due to such a yardstick comparison of residents, local governors are disciplined to exert maximum efforts toward supplying public goods (Besley and Case 1996, Besley and Smart 2007), although they fail in the optimal provision of public goods (Nishigaki et al. 2015).Furthermore, a political inter-relation among neighboring jurisdictions causes interdependence in policy decisions and mimicking of policy variables or tax rates in the yardstick competition. This interdependence of policy or tax rates caused by informational externality is frequently used as evidence of yardstick competition in empirical studies (Besley and Case 1996, Revelli 2006, Nishigaki et al. 2014).Tax competition among local governments, on the other hand, addresses interaction due to inter-jurisdictional mobility of the tax base. By using a competitive two-region model, studies have indicated that an unfavorable externality of loss in the tax base causes strategic behavior in tax setting and an undersupply of public goods arises as a result of intergovernmental competition (Wildersin 1988, Brueckner and Saavedra 2001). These studies have also indicated that even competition among benevolent governments with full information leads to unfavorable results.By introducing the production of private and public goods using the inter-regionally mobile factor of capital stock, this paper investigates tax competition in a yardstick competition model. The harmful effects of under-provision of public goods caused by tax competition and political competition are synthesized in the yardstick equilibrium. Furthermore, it is indicated that the externality caused by the loss in capital stock is internalized through the informational externality of the yardstick comparison.

Suggested Citation

  • Yasuyuki Nishigaki & Hideya Kato, 2016. "Yardstick Competition and Tax Competition -Intergovernmental Relations and Efficiency of Public Goods-," Proceedings of Economics and Finance Conferences 3205732, International Institute of Social and Economic Sciences.
    • Handle: RePEc:sek:iefpro:3205732
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    References listed on IDEAS

    as
    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-864, October.
    2. Revelli, Federico, 2006. "Performance rating and yardstick competition in social service provision," Journal of Public Economics, Elsevier, vol. 90(3), pages 459-475, February.
    3. Wildasin, David E., 1988. "Nash equilibria in models of fiscal competition," Journal of Public Economics, Elsevier, vol. 35(2), pages 229-240, March.
    4. Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416-416.
    5. Besley, Timothy & Smart, Michael, 2007. "Fiscal restraints and voter welfare," Journal of Public Economics, Elsevier, vol. 91(3-4), pages 755-773, April.
    6. Wilson, John Douglas & Wildasin, David E., 2004. "Capital tax competition: bane or boon," Journal of Public Economics, Elsevier, vol. 88(6), pages 1065-1091, June.
    7. Kotsogiannis, Christos & Schwager, Robert, 2008. "Accountability and fiscal equalization," Journal of Public Economics, Elsevier, vol. 92(12), pages 2336-2349, December.
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    9. Besley, Timothy & Case, Anne, 1995. "Incumbent Behavior: Vote-Seeking, Tax-Setting, and Yardstick Competition," American Economic Review, American Economic Association, vol. 85(1), pages 25-45, March.
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    Cited by:

    1. Tong Yang, 2020. "Effect of agency costs on the optimal matching grant rate in a model of tax competition with benefit spillovers," Palgrave Communications, Palgrave Macmillan, vol. 7(1), pages 1-6, December.

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    More about this item

    Keywords

    Local Public Goods; Asymmetric Information; Intergovernmental Externality; Yardstick Competition; Tax Competition;
    All these keywords.

    JEL classification:

    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior
    • H41 - Public Economics - - Publicly Provided Goods - - - Public Goods
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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