Capital-tax financing and scale economies in public-input production

Contrary to the dominant view of inefficient tax competition, Oates and Schwab (1991) show that capital-tax financing of public inputs leads to efficiency when the supply of these inputs is conditioned on business investment (Oates, W.E., Schwab, R.M., 1991. The allocative and distributive implications of local fiscal competition). This paper demonstrates that the cost structure of public-input production is relevant to their proposition on efficient capital-tax financing. That proposition holds if the per-unit cost of public inputs is exogenously fixed; however, it does not hold if public-input production exhibits scale economies. Also, this paper compares our analysis with the Zodrow-Mieszkowski model. That comparison illustrates the importance of the way public inputs are rationed to private firms.