Fiscal Competition, Revenue Sharing, and Policy-Induced Agglomeration

CORE Discussion Paper No. 2005/93

26 Pages Posted: 1 Mar 2006

See all articles by Jean Hindriks

Jean Hindriks

University of London - School of Economics and Finance

Susana Peralta

CORE-UCL; Nova School of Business and Economics

Shlomo Weber

Southern Methodist University (SMU) - Department of Economics; New Economic School

Date Written: December 2005

Abstract

Revenue sharing can be used to discourage low tax regions from competing for capital and firms with high tax regions. However, with heterogeneous regions, revenue sharing involves net transfers across regions and creates a moral-hazard problem - that is, regions may want to invest less in market fostering public good when the benefits are shared across nations. This paper analyzes these costs and benefits of revenue sharing. When asymmetric regions compete in capital income taxes only, we show that revenue sharing can be desirable for the high tax region if it is pushed far enough (i.e., J-curve effect), while tax harmonization is always harmful for the low tax region. When regions also compete through public investments, we find that tax competition distorts (downwards) public investments. While revenue sharing discourages public investments due to moral-hazard effect, it remains beneficial in most cases. Moreover, there are new agglomeration forces resulting from public investments, because the inflow of capital raises the incentive for public investments which in turn attract more capital. This leads to the possibility of policy-induced agglomeration (which is different from the classical agglomeration forces in the New Economic geography).

Keywords: Heterogeneous Regions, Fiscal Federalism, Revenue Sharing, Moral Hazard, Agglomeration

JEL Classification: C72, H23, H70

Suggested Citation

Hindriks, Jean and Peralta, Susana and Weber, Shlomo, Fiscal Competition, Revenue Sharing, and Policy-Induced Agglomeration (December 2005). CORE Discussion Paper No. 2005/93, Available at SSRN: https://ssrn.com/abstract=886291 or http://dx.doi.org/10.2139/ssrn.886291

Jean Hindriks (Contact Author)

University of London - School of Economics and Finance ( email )

Mile End Road
London, E1 4NS
United Kingdom
+44 20 7882 7807 (Phone)
+44 20 8983 3580 (Fax)

HOME PAGE: http://www.dc.eclipse.co.uk/hindriks.html

Susana Peralta

CORE-UCL

34 Voie du Roman Pays
1348 Louvain-la-Neuve, 1348
Belgium

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~peralta/

Shlomo Weber

Southern Methodist University (SMU) - Department of Economics ( email )

Dallas, TX 75275
United States
214-768-3577 (Phone)
214-768-1821 (Fax)

New Economic School ( email )

Moscow
Russia
+ 7-495-9569508 (Phone)

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