Revenue Decentralization, the Local Income Tax Deduction, and the Provision of Public Goods

42 Pages Posted: 19 Dec 2012 Last revised: 28 Jan 2013

Date Written: December 19, 2012

Abstract

We consider a model where local and national governments both tax income and use the revenue to invest in both productive and consumptive public goods. Local governments will overprovide the consumptive public good if the local income tax is (partially) deductible. However, without full deductibility, local governments will underprovide local productive public goods. Hence, to reduce the distortions in the local governments' decisions, the national government will underinvest in both types of public goods. We also consider an alternative fiscal structure where the national government sets one national tax rate and provides transfers to the local governments: this results in lower welfare than one where local governments raise revenue independently.

Keywords: Local tax deduction, Fiscal federalism, Fiscal externality, Public good provision

JEL Classification: H21, H23, H71, H72, H77

Suggested Citation

Hatfield, John William, Revenue Decentralization, the Local Income Tax Deduction, and the Provision of Public Goods (December 19, 2012). National Tax Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2191709

John William Hatfield (Contact Author)

University of Texas at Austin ( email )

Austin, TX 78712
United States

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