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Can fiscal equalisation mitigate tax competition? Ad valorem and residence-based taxation in a federation

Sas W (2017) Can fiscal equalisation mitigate tax competition? Ad valorem and residence-based taxation in a federation, International Tax and Public Finance, 24 (5), pp. 817-853.

In this paper, we revisit the combined effect of horizontal and vertical tax externalities in a federal context, extending the theoretical framework of Keen and Kotsogiannis (Am Econ Rev 92(1):363–370, 2002) by allowing for ad valorem and residence-based taxation. When taxes are levied ad valorem rather than per-unit firstly, we find the interaction between both types of externalities is more ambiguous than commonly understood. As a result, and contrary to earlier findings, fiscal equalisation mechanisms such as the representative transfer system (RTS) fail to fully internalise the tax externalities. Given these limitations, we derive the conditions under which a standard RTS will either: (1) at least nudge politicians in the right direction; (2) realise no welfare gains at all; (3) considerably overshoot the second-best efficiency mark causing welfare loss. Lastly, we find that when taxation is residence-based rather than source-based, a different kind of competition emerges where tax cuts are aimed at stimulating outward factor flows, rather than attracting inward flows.

Tax competition; Ad valorem taxation; Vertical and horizontal externalities; Fiscal equalisation; Residence-based taxation; Fiscal federalism

AuthorsSas Willem
Publication date09/2017
Publication date online13/01/2017
Date accepted by journal15/12/2016
PublisherInternational Tax and Public Finance
ISSN 0927-5940

International tax and Public Finance: Volume 24, Issue 5

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