We propose a theory of tax centralization in politico-economic equilibrium. Taxation has dynamic general equilibrium implications which are internalized at the federal, but not at the regional level. The political support for taxation therefore differs across levels of government. Complementarities on the spending side decouple the equilibrium composition of spending and taxation and create a role for inter governmental grants. The model provides an explanation for the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, it accounts for approximately 30% of the federal revenue share’s doubling in the 1930s, and for the long-term increase in federal grants.
University of Copenhagen, Department of Economics Discussion Paper 17-18, July 2017, with Martin Gonzalez-Eiras. PDF.
We propose a theory of tax centralization and intergovernmental grants in politico-economic equilibrium. The cost of taxation differs across levels of government because voters internalize general equilibrium effects at the central but not at the local level. The equilibrium degree of tax centralization is determinate even if expenditure-related motives for centralization considered in the fiscal federalism literature are absent. If central and local spending are complements, intergovernmental grants are determinate as well. Our theory helps to explain the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, the model can account for the postwar trend in federal grants, and a third of the dramatic increase in the size of the federal government in the 1930s.
In the NZZ,
- Legislation has become more centralized.
- Implementation less so. Cantons increasingly implement federal legislation.
- But decentralized authority to collect taxes has remained largely in place.
Figure from the NZZ:
In an interview with the NZZ, Christoph Schaltegger argues that Swiss cantons loose revenue when new firms move in, due to badly structured inter cantonal revenue sharing (Finanzausgleich).
On VoxEU, Paolo Pasimeni and Stéphanie Riso argue that at the EU level, cross-border redistribution is limited:
The EU budget accounts for roughly 1% of the EU’s GDP. Around 80% of it, on average, returns back to each country in the form of various allocated expenditures, and only a limited part is actually redistributed among countries. On average over the past 15 years, the redistribution operated by the budget at the level of the EU was equal to 0.2% of the Union’s GDP. As a matter of comparison, the average yearly cross-border flows operated through the federal budget in the US between 1980-2005 was equal to 1.5% of GDP (d’Apice 2015).
VoxEU, October 11, 2016, with Martin Gonzalez-Eiras. HTML.
- The US fiscal system underwent a radical transformation around the time of the Great Depression.
- Perceived cost differences of revenue collection across levels of government, due to general equilibrium effects, can partly explain the rise of tax centralization and intergovernmental grants.
- We develop a micro-founded general equilibrium model that blends politics and macroeconomics. (See the working paper.)
We propose a theory of tax centralization and inter governmental grants in politico-economic equilibrium. The cost of taxation differs across levels of government because voters internalize general equilibrium effects at the central but not at the local level. This renders the degree of tax centralization and the tax burden determinate even if none of the traditional, expenditure-related motives for centralization considered in the fiscal federalism literature is present. If central and local spending are complements and the trade-off between the cost of taxation and the benefit of spending is perceived differently across levels of government, inter governmental grants become relevant. Calibrated to U.S. data, our model helps to explain the introduction of federal grants at the time of the New Deal, and their increase up to the turn of the twenty-first century. Grants are predicted to increase to approximately 5.5% of GDP by 2060.