Vertical Externalities in a Tax Setting in a System of Hierarchical Governments

Abstract

This paper focuses on the overlap in the tax bases between two levels of government. This overlap leads to vertical fiscal externalities that arise when several different commodities are in the tax base and the tax bases of the two levels of government may not be identical. In the unified government’s case, if it is supposed that the marginal utilities of income for the two states are the same, the tax policy in state i not only considers the price elasticity and cross elasticity of each state, but also the shares of expenditure on commodities x1 and x2 in the different states. When the cross elasticity is zero, the tax rates on the same commodity sold in the different states and the price elasticity should be inversely related. If the cross elasticity of the commodities is zero, the higher the marginal utility of income of state i, the lower should be the tax rate set by the unified government in state i.

Share and Cite:

C. Wang and Y. Hsu, "Vertical Externalities in a Tax Setting in a System of Hierarchical Governments," Theoretical Economics Letters, Vol. 3 No. 3, 2013, pp. 135-141. doi: 10.4236/tel.2013.33021.

Conflicts of Interest

The authors declare no conflicts of interest.

References

[1] B. Dahlby, “Fiscal Externalities and the Design of Intergovernment Grants,” International Tax and Public Finance, Vol. 3, No. 3, 1996, pp. 397-412. doi:10.1007/BF00418952
[2] M. Keen, “Vertical Tax Externalities in the Theory of Fiscal Federalism,” IMF Staff Papers, Vol. 45, No. 3, 1998, pp. 454-485. doi:10.2307/3867412
[3] N. C. Chia and S. Y. Phang, “Motor Vehicle Taxes as an Environmental Management Instrument: The Case of Singapore,” Environmental Economics and Policy Studies, Vol. 4, No. 2, 2001, pp. 67-93.
[4] L. de Mello, “The Brazilian ‘Tax War’: The Case of Value-Added Tax Competition among the States,” Public Finance Review, Vol. 36, No. 2, 2008, pp. 169-193. doi:10.1177/1091142107299252
[5] W. H. Hoyt, “Tax Policy Coordination, Vertical Externalities and Optimal Taxation in a System of Hierarchical Government,” Journal of Urban Economics, Vol. 50, No. 3, 2001, pp. 491-516. doi:10.1006/juec.2001.2231
[6] B. Dahlby and L. S. Wilson, “Vertical Fiscal Externalities in a Federation,” Journal of Public Economics, Vol. 87, No. 5-6, 2003, pp. 917-930. doi:10.1016/S0047-2727(01)00137-2
[7] T. J. Besley and H. S. Rosen, “Vertical Externalities in a Tax Setting: Evidence from Gasoline and Cigarettes,” Journal of Public Economics, Vol. 70, No. 3, 1998, pp. 383-398. doi:10.1016/S0047-2727(98)00041-3
[8] A. Esteller-Moré and L. Rizzo, “(Uncontrolled) Aggregate Shocks or Vertical Tax Interdependence? Evidence from Gasoline and Cigarettes,” National Tax Journal, Vol. 64, 2011, pp. 353-380.
[9] M. Brülhart and M. Jametti, “Vertical versus Horizontal Tax Externalities: An Empirical Test,” Journal of Public Economics, Vol. 90, No. 10-11, 2006, pp. 2027-2062. doi:10.1016/j.jpubeco.2006.04.004
[10] T. Madiès, “Do Vertical Tax Externalities Lead to Tax Rates Being Too High? A Note,” Annals of Regional Science, Vol. 42, No. 1, 2008, pp. 225-233. doi:10.1007/s00168-007-0135-5

Copyright © 2023 by authors and Scientific Research Publishing Inc.

Creative Commons License

This work and the related PDF file are licensed under a Creative Commons Attribution 4.0 International License.