Income Tax Competition in a Federation : Evidence from a Natural Experiment

The issue of tax competition in a federation is tackled in this paper by Paul Boothe who examines the recent reforms concerning the financing of Canadian provinces. In 2000 and 2001 nine of the ten Canadian provinces moved from a tax system based on levying taxes as a percentage of the federal income tax to a system based on levying taxes directly on federally-defined taxable income. The introduction of the new provincial tax systems was expected to more closely meet local preferences. Therefore, a greater dispersion of income tax burdens across regions could have been expected. The paper compares marginal and average tax rates before and after the reform. The fact that the dispersion of taxation levels has not increased is interpreted by the author as the effect of tax competition. According to his view, in the Canadian context, characterised by high capital and labour mobility, tax competition has played a positive role by promoting harmonisation among provinces. However, it has not degenerated in harmful competition: provinces have not introduced measures which would distort the decisions about the location of economic activities