It is indeed possible that a tax might be laid on a particular article by a State which might render it inexpedient that..a further tax..be laid on the same article by the Union…The Federalist Papers2
Appendix I. Notes to table 1
Appendix ii. The sign of dt/dT
Appendix iii. The misallocation of public expenditure in the stackelberg equilibrium
Appendix iv. The welfare loss from concurrent taxation
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University of Essex, Wivenhoe Park, Colchester C04 3SQ and the Institute for Fiscal Studies, 7 Ridgmount Street, London WC1E 7AE. This paper was written while visiting the Fiscal Affairs Department of the International Monetary Fund, whose support and hospitality is acknowledged with many thanks. I am grateful to Russell Krelove, Howell Zee, and others in FAD for very helpful comments and suggestions; to Christos Kotsogiannis for allowing me to draw on our continuing joint work; and to Richard Bird for directing me to The Federalist Papers.
This is currently an issue in Russia, for example, with federal taxes collected by an agency whose officials may feel primary loyalty to local government, and as a result are reportedly vulnerable to pressure to retain federal money for regional use.
Significant recent contributions include Besley and Rosen (1996), Boadway, Marchand, and Vigneault (1996), Dahlby (1994, 1996), Hoyt (1996), and Wrede (1995). We also draw on the work of Boadway and Keen (1996), Keen (1995), and Keen and Kotsogiannis (1996).
As in the case of Russia, noted above.
Boadway and Keen (1996) touch on the impact of a federal labor tax on the state labor tax, but do not examine this in any detail. Besley and Rosen (1996) consider the case in which the state government needs to raise some arbitrarily fixed amount of revenue and there are many taxed goods. The purpose here, in contrast, is to develop the most fundamental aspects of the issue in some detail by casting co-occupation in its starkest form: federal taxation is allowed to affect the overall of expenditure chosen by the states, which is financed by a single instrument. This sharp focus leads to insights that are both new and basic, the most notable being the log convexity condition derived below.
For brevity, we simply normalize the private marginal utility to unity and absorb unchanging lump-sum income into the form of v(.).
Derivatives are indicated by a prime for functions of a single variable and by subscripts for functions of several.
Notice that any grants received or paid by the state government are here assumed independent of its tax decisions, a point to which we shall in due course return.
The analysis is much more complex, it should be noted, when demand for the taxed good depends on public expenditures: the rule (3) must then be amended to reflect such feedback effects, which also imply that changing T will cause the demand curve in Figure 1 to shift. The sign of dt/dT will then depend not only on the log convexity condition in the text but also on such imponderables as the effects of g and G on the slope of the demand curve. (For completeness, note that the independence of demand from g and G at issue here does not require quite such a strong condition as that in (1): it is enough that indirect utility be of the form V[v(q), Г (g, G)].)
This result continues to hold if the state tax is deductible against the federal; proof available on request.
This result assumes Г (g, G) to be additive.
Since p is constant, ad valorem and specific taxes are equivalent in the present context (as can be seen by simply setting p = 1 in the discussion that follows): nevertheless, deductibility is most easily thought of in terms of ad valorem taxation.
Denoting by λ the proportion of state taxes that are deductible against federal, maximizing state revenue tx(P + T+t(1- λT)) gives the necessary condition x(P+ T + α) +αx′ (P + T + α) = 0, where a = t(1 − λT). Thus an increase in λ will induce the state to adjust t so as to keep a constant: and hence dt/dλ > 0.
The proof of this is available on request.
Additional externalities may arise from the deductibility or crediting of tax payments to one level against payments to the other; our focus, however, is on effects arising from behavioral responses.
A unit increase in t increases state revenue by x + tx′ and reduces welfare by -V′ (q) = x: welfare loss per dollar of state revenue, at the margin, is thus given (after rearrangement) by the right of (4).
There can of course be horizontal externalities pointing to excessively high state taxes; tax exporting is the most obvious example. But it is pressures toward inefficiently low taxes that are most often emphasized—tax exporting requires that subnational jurisdictions have some degree of market power, so tends to arise in somewhat special contexts—and on which we concentrate.
For brevity, we do not consider the intermediate case in which the government takes as given one of the state fiscal variables but recognizes that the other is tied to it by the state revenue constraint: see Keen and Kotsogiannis (1996).
There then being in effect, no horizontal competition among the states comprising the federation but only between each state and the rest of the world.
Excluding social security: this does not affect the empirical point of interest here.
Data are for 1990.
This result is reasonably robust against changes in specification: significance of the coefficient on FED increases, for example, while the coefficient stays roughly the same, if social security taxes are included in the dependent variable.
The two taxes are drawn as strategic complements, but it is easily checked that this is inessential to the result: see the next footnote.
If the two taxes are strategic substitutes, the federal tax will be higher in the new equilibrium. But stability considerations imply that the consolidated tax rate will nevertheless fall, so that the same conclusions apply.
As will be the case, for example, in the model of Brennan and Buchanan (1977), which has leviathan constrained to spend some fixed proportion of tax revenues on socially productive items.
Or, as noted in the preceding section, one could also envisage a situation in which both levels retain tax powers, with the federal government able to replicate the unitary outcome by use of both its own distorting taxes and its ability to impose lump-sum taxes on the states.
More precisely, Dahlby (1996) points out that by taxing away a proportion π of state revenues, so that the state government’s problem becomes that of maximizing v (q) + Г((l − π) tx (q), G), the federal government can ensure that the MCPF perceived by the state coincides with the SMCPF by setting π = − (T/q) e (q)/(1 + (t/q)e(q)) (evaluated at the optimum).
I am indebted to Robin Boadway for this point.