Heterogeneous vertical tax externalities and macroeconomic effects of federal tax changes: The role of fiscal advantage

Fidel Perez-Sebastian, Ohad Raveh and Yaniv Reingewertz
Authors registered in the RePEc Author Service: Fidel Perez Sebastian

Journal of Urban Economics, 2019, vol. 112, issue C, 85-110

Abstract: How do state tax rates respond to federal tax shocks? This paper presents a novel mechanism of heterogeneous vertical tax externalities across state-levels of fiscal advantage, showing that tax increases can be expansionary – even without their reinvestment. States rich in natural resources have a fiscal advantage in the inter-state competition over production factors which allows them to respond better to increases in federal taxes and, consequently, attract capital from other parts of the nation. We add heterogeneity in fiscal advantage levels to an otherwise standard model of vertical tax externalities and horizontal tax competition. The model shows that, irrespective of federal redistribution, the contractionary effect of a federal tax increase can be overturned in fiscally advantaged states, through an increase in their tax base. Using the case of the U.S., and narrative-based measures of federal tax shocks a-la Romer and Romer (2010), we provide empirical evidence for the various aspects of this mechanism. Specifically, our baseline estimates indicate that, controlling for federal transfers, a 1% increase in the GDP share of capital-related federal taxes at the beginning of a year increases the growth rate of the per capita tax base by approximately 0.7% in high fiscal advantage states at the end of it.

Keywords: Federalism; Natural resources; Fiscal advantage; Tax competition (search for similar items in EconPapers)
JEL-codes: H77 Q32 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Heterogeneous Vertical Tax Externalities and Macroeconomic Effects of Federal Tax Changes: The Role of Fiscal Advantage (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:juecon:v:112:y:2019:i:c:p:85-110

DOI: 10.1016/j.jue.2019.06.003

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