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Fiscal competition, revenue sharing, and policy-induced agglomeration

Author

Listed:
  • HINDRIKS, Jean
  • PERALTA, Susana
  • WEBER, Shlomo
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).

Suggested Citation

  • HINDRIKS, Jean & PERALTA, Susana & WEBER, Shlomo, 2005. "Fiscal competition, revenue sharing, and policy-induced agglomeration," LIDAM Discussion Papers CORE 2005093, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2005093
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Carl Gaigné & Stéphane Riou, 2007. "Globalization, Asymmetric Tax Competition, and Fiscal Equalization," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(5), pages 901-925, October.
    2. C. Dembour, 2008. "Competition for Business Location: A Survey," Journal of Industry, Competition and Trade, Springer, vol. 8(2), pages 89-111, June.
    3. Zemanek, Holger, 2009. "Fiscal Transfers and Structural Reforms in the European Monetary Union," MPRA Paper 19357, University Library of Munich, Germany.

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    More about this item

    Keywords

    heterogeneous regions; fiscal federalism; revenue sharing; moral hazard; agglomeration;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H70 - Public Economics - - State and Local Government; Intergovernmental Relations - - - General

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