TITLE:
Vertical Externalities in a Tax Setting in a System of Hierarchical Governments
AUTHORS:
Chao-Lan Wang, Yi-Chung Hsu
KEYWORDS:
Vertical Externality; Optimal Tax Rate
JOURNAL NAME:
Theoretical Economics Letters,
Vol.3 No.3,
June
7,
2013
ABSTRACT: This paper focuses on the overlap in the
tax bases between two levels of government. This overlap leads to vertical fiscal
externalities that arise when several different commodities are in the tax base
and the tax bases of the two levels of government may not be identical. In the
unified government’s case, if it is supposed that the marginal utilities of
income for the two states are the same, the tax policy in state i not only considers the price
elasticity and cross elasticity of each state, but also the shares of
expenditure on commodities x1 and x2 in the different
states. When the cross elasticity is zero, the tax rates on the same commodity
sold in the different states and the price elasticity should be inversely
related. If the cross elasticity of the commodities is zero, the higher the
marginal utility of income of state i,
the lower should be the tax rate set by the unified government in state i.