What Drives Vertical Fiscal Interactions? Evidence from the 1980 Crude Oil Windfall Act

55 Pages Posted: 3 Aug 2016 Last revised: 2 Nov 2018

See all articles by Fidel Perez‐Sebastian

Fidel Perez‐Sebastian

Universidad de Alicante - Department of Economic Analysis

Ohad Raveh

Hebrew University of Jerusalem

Date Written: October 2018


In economies with multi-level governments, why would a change in the fiscal rule of a government in one level lead to a fiscal response by a government in a different level? The literature focused primarily on the standard common-pool problem, while giving little attention to the potential role of complementarity or substitutability (CS) between the public goods supplied by the two governments. This paper fills this gap by focusing on the latter channel. First, we illustrate its potential key role in determining the sign of the vertical reaction through a generic model of vertical fiscal interactions. Second, we propose a novel strategy for identifying it, by considering an empirical design that confines the common-pool channel to specific locations. We implement this design through a quasi-natural experiment: the 1980 U.S. Crude Oil Windfall Act, which increased federal tax collections from sale of crude oil, thereby affecting the tax base of oil rich states specifically. This latter feature enables attributing the vertical fiscal reactions of the remaining states to the CS channel. Following this strategy, via a difference-in-differences approach, we decompose the sources of the vertical fiscal reactions arising from this federal tax change and find that those attributed to the CS channel: (i) account for approximately 38% of the overall vertical fiscal response; (ii) point at complementarity between state and federal public goods, most notably in transportation and welfare expenditures; (iii) are manifested primarily via changes in states' sales and income taxation.

Keywords: Federalism, vertical tax externalities, common-pool problem, complementarities, natural resources

JEL Classification: H77, H71, Q32

Suggested Citation

Perez Sebastian, Fidel and Raveh, Ohad, What Drives Vertical Fiscal Interactions? Evidence from the 1980 Crude Oil Windfall Act (October 2018). Regional Science and Urban Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2817039 or http://dx.doi.org/10.2139/ssrn.2817039

Fidel Perez Sebastian

Universidad de Alicante - Department of Economic Analysis ( email )

03080 Alicante

Ohad Raveh (Contact Author)

Hebrew University of Jerusalem ( email )

Mount Scopus
Jerusalem, 91905

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