Heterogeneous vertical tax externalities and macroeconomic effects of federal tax changes: The role of fiscal advantage

Fidel Perez-Sebastian, Ohad Raveh, Yaniv Reingewertz

Research output: Contribution to journalArticlepeer-review

Abstract

How do state tax rates respond to federal tax shocks? This paper presents a novel mechanism of heterogeneous vertical tax externalities across state-levels of fiscal advantage, showing that tax increases can be expansionary – even without their reinvestment. States rich in natural resources have a fiscal advantage in the inter-state competition over production factors which allows them to respond better to increases in federal taxes and, consequently, attract capital from other parts of the nation. We add heterogeneity in fiscal advantage levels to an otherwise standard model of vertical tax externalities and horizontal tax competition. The model shows that, irrespective of federal redistribution, the contractionary effect of a federal tax increase can be overturned in fiscally advantaged states, through an increase in their tax base. Using the case of the U.S., and narrative-based measures of federal tax shocks a-la Romer and Romer (2010), we provide empirical evidence for the various aspects of this mechanism. Specifically, our baseline estimates indicate that, controlling for federal transfers, a 1% increase in the GDP share of capital-related federal taxes at the beginning of a year increases the growth rate of the per capita tax base by approximately 0.7% in high fiscal advantage states at the end of it.

Original languageEnglish
Pages (from-to)85-110
Number of pages26
JournalJournal of Urban Economics
Volume112
DOIs
StatePublished - Jul 2019

Bibliographical note

Publisher Copyright:
© 2019 Elsevier Inc.

Keywords

  • Federalism
  • Fiscal advantage
  • Natural resources
  • Tax competition

ASJC Scopus subject areas

  • Economics and Econometrics
  • Urban Studies

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