Tax competition and tax structure in open federal economies: Evidence from OECD countries with implications for the European Union

Tax competition arguments suggest that governments that operate in an open economy (such as local governments) should not and will not rely on non-benefit taxes, such as the income tax. Yet we observe reliance on income taxes by local governments in many countries, and such reliance changes over time. Evidence from a panel data set of 13 OECD countries over the period 1975-1984 suggests that competition between levels of government (resulting in a vertical fiscal externality) and between governments at the same level (resulting in a horizontal fiscal externality) provide some economic rationale for these changes. Moreover, the evidence indicates that the vertical and horizontal fiscal externalities interact. These results have some interesting implications for fiscal policy in the European Union, particularly as the EU continues to evolve. One implication for the EU is that enlargement that increases tax base disparities within the EU (and is not accompanied by an EU-level income tax) will tend to lower national income tax rates, although this must be qualified because it also depends on the mobility of the population. A second implication is that fiscal expansion of the EU to include an EU-level income tax may tend to lower the reliance of national governments on income taxes through the vertical externality, but may also tend to equalize tax bases across countries, and so increase reliance on national income taxes through the horizontal externality.     

Fiscal decentralization and government quality in the OECD

Using indicators of fiscal decentralization which control for intergovernmental transfers and grants, it is shown that decentralization has a positive impact on government quality but that this positive effect is mitigated in the presence of regional elections and multi-level government.     

Designing tax policy in federalist economies: An overview

The emerging economic federations of the European Union, Russia, and South Africa, along with the established federations in Australia, Canada, and the United States, confront the task of designing the institutions for federal fiscal policy. This paper reviews the literature on the design of tax policy in federalist economies. We conclude that taxation by lower level governments can lead to significant economic inefficiencies and inequities. The usual ‘assignment’ view of federalis recommends central government policies — for example, resident-based taxation or grants-in-aid — to correct these failures. These recommendations assume that the central government will act as a benevolent social planner. The ‘political economy’ view of federalism suggests that this assumption is in error and that additional federalist institutions must be considered. Alternative legislative structures and constitutional rules are considered.     

Political bargaining in a federation: Buchanan meets Coase

In recent decades, the issues of federalism and political integration have gained prominence in public debate as well as in the academic realm. A frequently made point is that allowing free secession may protect the minority's interests, thus providing it with an incentive to enter the federation. This paper explicitly considers the political process in the federation arguing that the option to secede may distort the political choices made by the individual regions to improve their bargaining positions. As a result, the allocation of resources in the federation could well end up being inefficient and unattractive for the minority region. In contrast, limiting the secession possibilities by requiring the consent of a majority of voters through a regional referendum, rather than leaving it to the discretion of the legislature, restores efficiency.     

A stylized model of overrepresentation and quality in the Congress

Traditionally, overrepresentation has been used to explain the distribution of benefits across jurisdictions, leaving aside quality components. We present a model that demonstrates that in the dispute of limited federal benefits, although quantity is important, at the margin quality matters.     

Accountability and fiscal equalization

A common feature of multi-jurisdictional systems is equalization programs. The implementation of such programs, that is based on some measurement of sub-national fiscal capacity and effort, is particularly complex. Within a political economy model, this paper analyzes the impact of such systems on accountability, identifying a positive and a negative effect. The positive effect arises because with equalized fiscal resources, a consequence of equalization, citizens attach more importance to any remaining variation in public good supplies and so punish rent-taking more severely. This induces politicians to restrain themselves and so accountability improves. The negative effect arises because the complexity of such programs reduces the informational content of observed public good supplies. This introduces a perverse fiscal incentive that reduces accountability. Thus, the overall impact of equalization programs on accountability depends on the balance of these effects.     

POVERTY TRAPS WITH LOCAL ALLOCATION TAX GRANTS IN JAPAN

This essay investigates poverty traps related to Local Allocation Tax (LAT) grants in Japan. LAT grants, which are transfers of funds from the central government to local governments, make efforts for enhancing regional economic growth, due to the calculation of the LAT grants. Using a simple dynamic model, we show that LAT grants lower regional income and are a disincentive to localities to increase their estimated tax revenue. Using panel Granger (non‐)causality tests, we find empirical support for asserting that there are poverty traps due to the LAT grants in Japan.     

Interregional redistribution and budget institutions under asymmetric information

Empirical evidence from the U.S. and the European Union suggests that regions which contribute to interregional redistribution face weaker borrowing constraints than regions which benefit from interregional redistribution. This paper presents an argument in favor of such differentiated budget institutions. It develops a two period model of a federation consisting of two types of regions. The federal government redistributes from one type of regions (contributors) to the other type (recipients). It is shown that a fiscal constitution with lax budget rules for contributors and strict budget rules for recipients solves the self selection problem the federal government faces in the presence of asymmetric information regarding exogenous characteristics of the regions.     

Supermodularity and preferences

We uncover the complete ordinal implications of supermodularity on finite lattices under the assumption of weak monotonicity. In this environment, we show that supermodularity is ordinally equivalent to the notion of quasisupermodularity introduced by Milgrom and Shannon. We conclude that supermodularity is a weak property, in the sense that many preferences have a supermodular representation.     

Effective global regularity and empirical modelling of direct, inverse, and mixed demand systems

Abstract .  This paper utilizes the notion of 'effective global regularity' and the intuition stemming from Cooper and McLaren (1996)'s General Exponential Form to develop a family of 'composite' (product and ratio) direct, inverse and mixed demand systems. Apart from having larger regularity regions, the resulting specifications are also of potentially arbitrary rank, which can better approximate non-linear Engel curves. We also make extensive use of duality theory and a numerical inversion estimation method to rectify the endogeneity problem encountered in the estimation of the mixed demand systems. We illustrate the techniques by estimating different types of demand systems for Japanese quarterly meat and fish consumption.     

On behavioral complementarity and its implications

We study the behavioral definition of complementary goods: if the price of one good increases, demand for a complementary good must decrease. We obtain its full implications for observable demand behavior (its testable implications), and for the consumer's underlying preferences. We characterize those data sets which can be generated by rational preferences exhibiting complementarities. The class of preferences that generate demand complements has Leontief and Cobb-Douglas as its as extreme members.     

Mortality risks,education and child labor

In this paper, we investigate the role of young adult mortality on child labor and educational decisions. We argue that mortality risks are a major source of risks in returns to education in developing countries. We show that, in the absence of appropriate insurance mechanisms, the level of child labor is inefficient, but it can be too high or too low. It is too high when parents are not very altruistic and anticipate positive transfers from their children in the future. Uncertain returns to education, endogenous mortality or imperfect capital markets unambiguously increase child labor. When the level of child labor is inefficiently high, we also show that a cash transfer conditional on child's schooling can always restore efficiency regarding child labor.     

Local public goods, inter-regional transfers and private information

Suppose that the centre wishes to make transfers between member states of a federation to reduce inequality. However, it lacks precise information concerning the cost differences that are responsible for the initial income inequality. We examine the implications of asymmetric information for the design of the transfer scheme. We show that if member states’ inherent cost levels as local public good providers take discrete values, the first best, or ‘complete information’, transfer scheme may or may not violate incentive compatibility. If inherent cost is a continuous random variable, such a scheme certainly violates incentive compatibility. We also explore the possibility of binding participation constraints. In our model, a binding incentive compatibility constraint leads to a reduction in effort devoted to cost reduction, and a binding participation constraint will also lead to a violation of Samuelson's optimality condition for public good provision.