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Vertical Fiscal Externalities and Federal Tax-Transfers under Variable Factor Supplies

Nikos Tsakiris (), Panos Hatzipanayotou () and Michael Michael

CESifo Economic Studies, 2019, vol. 65, issue 3, 296-317

Abstract: Within a model of variable supply of capital due to international mobility and variable labor supply due to endogenous labor-leisure choice, we revisit the issues of vertical fiscal externalities, and of federal tax-transfers. Capital and labor taxes by federal and state governments finance the provision of federal and of state public consumption goods. When capital and labor are substitutes in production, we show that (i) the state’s optimal policy calls for capital and labor taxes, (ii) the vertical fiscal externality can be reversed from negative, implying inefficiently high noncooperative capital taxes, to positive, implying inefficiently low noncooperative capital taxes, and (iii) under centralized leadership the federal government replicates the second best optimum with a capital tax, and possibly, top-down transfers.

Keywords: fiscal federalism; vertical fiscal externalities; bottom-up and top-down transfers; variable factor supplies (search for similar items in EconPapers)
JEL-codes: F18 F21 H21 (search for similar items in EconPapers)
Date: 2019
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