Local government responsiveness to federal transfers: theory and evidence |
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Authors: | Leonzio Rizzo |
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Institution: | (1) Department of Economics, University of Ferrara, Via Voltapaletto 11, Ferrara, Italy |
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Abstract: | Federal transfers can depend on local fiscal capacity which is measured by local tax bases. The aim of this paper is to understand
to what extent and how these transfers affect local tax decisions. We develop a model with two provinces producing one mobile
good. The good is taxed according to the destination principle. Final consumers decide to buy the good from the province where
it is cheaper. The two provinces engage in tax competition. The introduction of scale economies into the shopping technology
generates nonlinear tax reaction functions which make it possible to test the effect of a transfer equalizing local tax bases
on tax competition in two complementary tax regimes. Used for this purpose are cigarette and gasoline tax data from Canada.
In the case of cigarette tax, it is found that nonlinearity in tax competition is almost entirely offset when equalization
holds: tax competition in the two tax regimes become closer. The shopping technology for gasoline gives less scope for scale
economies, so that equalization does not affect reaction functions.
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Keywords: | Fiscal competition Equalization Transfer Externality Tax-rate |
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