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Does Tax Competition Tame the Leviathan?

  • Mario Jametti

    ()

    (Department of Economics, York University)

  • Marius Brülhart

    ()

    (University of Lausanne)

We study the impact of tax competition on equilibrium taxes and welfare, focusing on the jurisdictional fragmentation of federations. In a representative-agent model of fiscal federalism, fragmentation among jurisdictions with benevolent tax-setting authorities unambiguously reduces welfare. If, however, tax-setting authorities pursue revenue maximization, fragmentation, by pushing down equilibrium tax rates, may under certain conditions increase citizen welfare. We exploit the highly decentralized and heterogeneous Swiss fiscal system as a laboratory for the estimation of these e¤ects. While for purely direct-democratic jurisdictions (which we associate with benevolent tax setting) we find that tax rates increase in fragmentation, fragmentation has a moderating e¤ect on the tax rates of jurisdictions with some degree of delegated government. Our results thereby support the view that tax competition can be second-best welfare enhancing by constraining the scope for public-sector revenue maximization.

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File URL: http://dept.econ.yorku.ca/research/workingPapers/working_papers/2007/Leviathan79.pdf
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Paper provided by York University, Department of Economics in its series Working Papers with number 2007_7.

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Length: 38 pages
Date of creation: Sep 2007
Date of revision:
Handle: RePEc:yca:wpaper:2007_7
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