How Fiscal Decentralization Flattens Progressive Taxes

We study the tension between fiscal decentralization and progressive taxation. We present a multi-community model in which the local income tax rate is determined by an exogenous progressive tax schedule and a tax shifter that can differ across communities. The progressivity of the tax schedule induces a self-sorting process that results in substantial though imperfect income sorting. Rich households are more likely to locate themselves in low tax communities than poor households. The actual tax structure is thus less progressive than the exogenous tax schedule. To investigate the quantitative implications of our model, we calibrate a fully-specified version to the largest metropolitan area in Switzerland. The equilibrium values of the simulation show the same pattern across communities as we observe in this area. The theoretical result is challenged by estimating the actual tax structure faced by the households in this area. We find that the actual tax structure is indeed substantially less progressive than the fixed tax schedule.