Public Provision and Local Income Tax Competition

Abstract

We extend the literature on local income tax competition by allowing for inter-jurisdictional spillovers and imperfect rivalry in consumption of a publicly provided good. Comparing decentralized second-best results of a theoretical model with an efficient benchmark, we identify three inefficiencies:

(1) imperfect redistribution;

(2) inter-community free-riding; and

(3) an inefficient allocation of the population.

We quantify the relative size of these inefficiencies in a numerical implementation of the theoretical model, which reveals that free-riding rises unambiguously in the level of spillovers, whereas the welfare losses from (1) and (3) depend non-linearly on the levels of spillovers and rivalry.

Keywords: publicly provided goods, tax competition, fiscal federalism, decentralization, free-riding, welfare analysis

JEL Classification: H210, H400, H770, Q580