The Consequences of Overlapping Tax Bases for Redistribution and Public Spending in a Federation

NOTE: The following is a description of the paper and not the actual abstract. Equilibrium tax and expenditure policies are studied in a federation consisting of a federal government and several state governments. Each state begins with an initial distribution of residents of different ability types.Households are mobile among states with psychic mobility costs reflecting differing degrees of attachment to home.States, behaving as Nash competitors, implement a linear progressive tax, and finance a state public good from the proceeds of the tax and a transfer from the federal government.State fiscal policies can be inefficient for two reasons.A vertical fiscal externality, which involves neglecting the effects of their policies on the federal government budget, provides an incentive to set tax rates and expenditure levels too high, leading to excessively progressive fiscal structures.A horizontal fiscal externality induces states to reduce taxes and expenditures, and to make fiscal structures less progressive than is optimal because of the effect of these policies on migration.The federal government, acting as stackelberg leader, implements its own linear progressive tax and expenditure policies and makes transfers to the states.We characterize the way in which the federal policy mix is used to counteract the vertical and horizontal fiscal externalities of the states.In the simplest case of homogeneous states where the lowest ability persons are mobile, we find that, despite the horizontal externalities, the use of redistributive taxation can be decentralized to the states: the federal government can nullify the horizontal externalities by an appropriate set of transfers.We also study the case of heterogeneous states and the case where state fiscal instruments are restricted