Tax Incentives in Fiscal Federalism: An Integrated

Models of …scal federalism rarely account for the multitude of real-world intergovernmental arrangements when assessing the e¢ ciency implications of tax competition; in particular for federal tax policy. This paper shows that …scal institutions such that federal tax deductibility, vertical revenue-sharing, and …scal equalization (being common features of existing federations) encourages taxation locally, but may discourage federal taxation. Furthermore, the structure of public spending is skewed towards local spending in …scal federalism. We also show that, when considering Leviathan governments, …scal institutions reduce con…scatory taxation by the federal government. The result is contrary to the Cartelization Hypothesis (Brennan and Buchanan, 1980). Finally, we characterize the e¢ cient design of intergovernmental …scal ties.