nep-pbe New Economics Papers
on Public Economics
Issue of 2009‒04‒05
twenty papers chosen by
Oliver Budzinski
Philipps-University of Marburg

  1. A Median Voter Model of the Vertical Fiscal Gap By Dahlby, Bev; Rodden, Jonathan; Wilson, Sam
  2. The Architecture of Federations: Constitutions, Bargaining, and Moral Hazard By Kessler, Anke; Luelfesmann, Christoph; Myers, Gordon M
  3. The Optimal Taxation Approach to Intergovernmental Grants By Dahlby, Bev
  4. Are your firmÕs taxes set in Warsaw? Spatial tax competition in Europe By CrabbŽ, Karen; VANDENBUSSCHE, Hylke
  5. Optimal nonlinear redistributive taxation and public good provision in an economy with Veblen effects By Micheletto, Luca
  6. Preference for Income Taxation with Several Heterogeneous Consumers By Torregrosa, Ramon. J.
  7. Corporate Tax Evasion: the Case for Specialists By Lipatov, Vilen
  8. The Marginal Cost of Public Funds and the Flypaper Effect By Dahlby, Bev
  9. Public goodsÕ attractiveness and migrations By GABSZEWICZÊ, JeanÊ; Gvetadze, Salome; Laussel, Didier; Pieretti, Patrice
  10. Corporate Taxation and Multinational Activity By Peter Egger; Simon Loretz; Michael Pfaffermayr; Hannes Winner
  11. State Corporation Income Taxation; An Economic Perspective on Nexus By David Wildasin
  12. A Note on the Cost-Benefit Ratio in Self-Enforcing Agreements By Hennlock, Magnus
  13. Sales Tax Reform in Ontario: The time is Right By Finn Poschmann
  14. Addressing Regional Inequality Issues in Bangladesh Public Expenditure By Mahmoud, Chowdhury Shameem; Wadood, Syed Naimul; Ahmed, Kazi Sabbir
  15. 'Klin'-ing up: effects of Polish tax reforms on those in and on those out By Leszek Morawski; Michal Myck
  16. Should We Tax or Cap Political Contributions? A Lobbying Model with Policy Favors and Access By Christopher Cotton
  17. The Incidence of Tax Credits for Hybrid Vehicles By James M. Sallee
  18. Too Many Municipalities? By Dahlby, Bev
  19. Regional Tax Differences and Multinational Profits in Europe By Murphy, Alan P.
  20. The economics of a temporary VAT cut By Thomas Crossley; Hamish Low; Matthew Wakefield

  1. By: Dahlby, Bev (University of Alberta, Department of Economics); Rodden, Jonathan (Stanford University); Wilson, Sam (University of Alberta, Department of Economics)
    Abstract: A median voter model is developed to explain the size of the vertical fiscal gap in a federation, i.e. the extent to which subnational governments' expenditures exceed their own-source tax revenues. In our model, individuals vote in subnational elections and in federal elections to determine tax rates and spending on public services by each level of government and transfers to the subnational governments. In the resulting political equilibrium, intergovernmental transfers from the central government are affected by the tax sensitivity of the tax bases of the central and subnational governments, the degree of inequality in the tax bases of the subnational governments, the allocation of spending responsibilities between the central and subnational governments, and whether the federal legislature is unicameral or bicameral.
    Keywords: intergovernmental grants; median voter model; fiscal federalism; vertical fiscal gap; vertical fiscal imbalance
    JEL: H71 H72 H77
    Date: 2009–01
  2. By: Kessler, Anke; Luelfesmann, Christoph; Myers, Gordon M
    Abstract: The paper studies a federal system where a region provides non-contractible essential inputs for the successful implementation of a local public policy project with spill-overs, and where bargaining between different levels of government may ensure efficient decision making ex post. We ask whether the authority over the public policy measure should rest with the local government or with the central government, allowing financial relationships within the federation to be designed optimally. Centralization is shown to dominate when governments are benevolent. With regionally biased governments, both centralization and decentralization are suboptimal as long as political bargaining does not take place. With bargaining, however, the first best can often be achieved under decentralization, but not under centralization. At the root of this result is the alignment of decision making over essential inputs and project size under decentralized governance.
    Keywords: Constitutions; Decentralization; Federalism; Grants; Political Bargaining
    JEL: D23 D78 H21 H77
    Date: 2009–03
  3. By: Dahlby, Bev (University of Alberta, Department of Economics)
    Abstract: An optimal tax system equates the marginal cost of public funds across all tax bases. This idea is applied to a federation to derive the optimal unconditional transfers that will promote an optimal allocation of taxation and expenditures among the governments in the federation. This approach provides insights into the concepts of vertical and horizontal fiscal imbalance, fiscal capacity, and fiscal need. Expressions for the optimal fiscal equalization grant and the optimal vertical fiscal gap are derived. We also show how the marginal cost of public funds affects the optimal matching grant rate for activities that generate expenditure externalities.
    Keywords: intergovernmental grants; median voter model; fiscal federalism; vertical fiscal gap; vertical fiscal imbalance; fiscal capacity; fiscal need
    JEL: H21 H71 H72 H77
    Date: 2009–03–10
  4. By: CrabbŽ, Karen; VANDENBUSSCHE, Hylke (UniversitŽ catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))
    Abstract: Tax competition within the EU is Þercer than in the rest of the OECD with tax rates falling rapidly. This paper analyzes tax responses of EU-15 countries to corporate tax changes in the EU-10 new member states as a function of their proximity to these new member states. The average corporate tax rate in the new member states has always been considerably lower than the average in the EU-15 countries. Their entry into the EU eliminated capital barriers, allowing Þrms to locate in one of the new EU-10 with full access to the European Market. Our results indicate that EU-15 countries geographically closer to the new member states respond stronger to corporate tax changes in these new member states. We use a theoretical and a spatial regression framework to test the hypothesis that distance to a low tax region intensiÞes countriesÕ tax reaction functions.
    Keywords: spatial tax competition, corporate taxes, fiscal reaction function.
    JEL: H25 H77 H39
    Date: 2008–12
  5. By: Micheletto, Luca (Uppsala Center for Fiscal Studies)
    Abstract: This paper deals with the consequences of the assumption of negatively interdependent preferences for the shape of the optimal nonlinear income tax and the efficient level of public good provision in a setting where the policy maker maximizes an inequality averse social welfare function and the agents´market ability is private information. The analysis points out that the terms added in the tax formulas due to the presence of Veblen e¤ects might justify a reduction in the optimal marginal tax rates faced by the different individuals. Also, the desir- ability of negative marginal tax rates cannot be ruled out. With respect to the issue of the optimal level of public good provision, we derive a modified Samuelson rule and highlight the fact that the Veblen-based part of the formula might require to distort downwards the efficient level of public good provision.
    Keywords: optimal nonlinear income taxation; modified Samuelson rule; Veblen effects
    JEL: H21 H23 H41
    Date: 2009–03–30
  6. By: Torregrosa, Ramon. J.
    Abstract: The dominance of income over commodity taxation for the single consumer case, implies that if the consumer is asked about what tax she would pay to bear a given tax burden, she would choose income taxation. This paper provides a version of this preference for income taxation for the case of several heterogeneous consumers by means of a game where the government allows each consumer to choose between the two tax regimes.
    Keywords: Income (direct) taxation; commodity (indirect) taxation.
    JEL: H31
    Date: 2008–10
  7. By: Lipatov, Vilen
    Abstract: Economists agree that accounting specialists are helpful in avoiding taxes. We argue that such help can often be called sophisticated evasion. We analyze it in a game of incomplete information played by tax authority, corporate taxpayers and accounting specialist. When sophisticated evasion is very common, marginal changes in enforcement are not effective, so radical measures are needed for improving compliance. Fines on firms as opposed to specialist are more effective in facilitating such measures. When the evasion is modest, auditing and accounting costs as opposed to fines are more effective in curbing it.
    Keywords: tax evasion; tax avoidance; sophisticated evasion
    JEL: H32 H26
    Date: 2005–05
  8. By: Dahlby, Bev (University of Alberta, Department of Economics)
    Abstract: A lump-sum intergovernmental transfer has a "price effect", as well as an "income effect", because it allows the recipient government to reduce its tax rate, which lowers its marginal cost of public funds, while still providing the same level of public service. This reduction in the effective price of providing the public service helps to explain the "flypaper effect" - the empirical observation that a lump-sum grant has a much larger effect on spending than an increase in personal income. Contrary to the assertions of Mieszkowski (1994) and Hines and Thaler (1995), a model of a benevolent local government financing its expenditures with a distortionary tax predicts flypaper effects from lump-sum grants that are similar to those observed in many econometric studies
    Keywords: flypaper effect; marginal cost of public funds; intergovernmental grants; fiscal federalism
    JEL: H71 H72 H77
    Date: 2009–01
  9. By: GABSZEWICZÊ, JeanÊ (UniversitŽ catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); Gvetadze, Salome (UniversitŽ catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); Laussel, Didier; Pieretti, Patrice
    Abstract: The aim of this paper is to develop a dynamic model of migrations, in which migration is driven by size asymmetries between countries and by the relative preferences of consumers between private consumption and consumption of public goods. The dynamic trajectories heavily depend on the degree of attractiveness for public goods We show that monotone migrations require sufficiently strong preferences for public goods, and can only be sustained from the small to the large countries. We identify the threshold value of the public goodsÕ intensity of preferences guaranteeing the survival of the small country. For weaker preference intensities, oscillating migrations may arise, but they Þnally converge to situation where both countries are of equal size.
    Keywords: migration, public goods, income tax.
    JEL: H
    Date: 2008–12
  10. By: Peter Egger (Ifo Institute and University of Munich); Simon Loretz (Oxford University Centre for Business Taxation); Michael Pfaffermayr (Department of Economics and Statistics, University of Innsbruck); Hannes Winner (Institute of Economics and Business Administration, University of Salzburg)
    Abstract: This paper assesses the impact of corporate taxation on multinational activity. A numerically solvable general equilibrium model of trade and multinational firms is used to incorporate the following components of corporate taxation: parent and host country statutory corporate tax rates, withholding tax rates, and parent and host country depreciation allowances. We account for their differential impact under alternative methods of double taxation relief (i.e., credit, exemption, and deduction). The hypotheses regarding the effects of changes in the tax parameters are investigated in a panel of bilateral outbound stocks of foreign direct investment (FDI) from 52 parent and 45 host countries for the years 1991 to 2004. For this, we compile annual information on taxation to construct the largest existing panel of tax parameters at the bilateral level based on national tax law and bilateral tax treaties. Our findings indicate that the parent country’s statutory corporate tax rate tends to foster outward FDI, whereas the host country’s statutory corporate and withholding tax rates are negatively associated with outward FDI. Depreciation allowances exert a significant impact on FDI, as hypothesized.
    Keywords: Corporate taxation; Foreign direct investment; Panel econometrics
    JEL: H25 H73 F21 F23 C33
    Date: 2009
  11. By: David Wildasin (Martin School of Public Policy and Administration and Department of Economics, University of Kentucky)
    Abstract: Acting in the interest of their residents, within limits imposed by Federal statute and by the Constitution, states have incentives to impose taxes on the profits of corporations owned by nonresidents. This paper presents a model within which a state, using an apportionment formula that includes a sales factor, would choose to tax the income of out-of-state corporations that derive revenues from the sale or licensing of intangible assets to in-state customers, provided that such corporations have sufficient nexus to be taxable. Although such policies enable states to capture rents from nonresidents, they also introduce tax distortions by imposing implicit tariffs on sales by out-of-state firms.
    JEL: H7
    Date: 2009–03
  12. By: Hennlock, Magnus (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: Since the analysis of a self-enforcing agreement by Barrett (1994) it has been clear that the ratio between the slopes of the marginal cost and marginal benefit functions is conclusive for stability of self-enforcing agreements. For example Finus and Rundshagen (1998) stated: 'it turns out that all qualitative results depend only on this ratio' as it determines the non-orthogonal free-riding response along Nash reaction functions. This note shows that this 'pure' connection between the cost-benefit ratio and non-orthogonal free-riding response occurs due to the 'anonymous contributions' property of public goods, and in such cases the cost-benefit ratio effect holds regardless the functional form of objectives, the formulation of congestion or the degree of impureness of the public good. Therefore we expect to see the cost-benefit ratio still be the conclusive component also in self-enforcing agreements based on more general functional forms than seen hitherto in the literature.
    Keywords: public goods; self-enforcing agreements; reaction function; coalition theory
    JEL: C70 H40
    Date: 2009–04–03
  13. By: Finn Poschmann (C.D. Howe Institute)
    Abstract: Putting an end to Ontario’s archaic retail sales tax and adopting a value-added tax like the GST would sharply lower the effective tax rate on new business investment and offer the province a much-needed economic boost.
    Keywords: sales tax, VAT, consumer prices
    JEL: H71 R51
    Date: 2009–03
  14. By: Mahmoud, Chowdhury Shameem; Wadood, Syed Naimul; Ahmed, Kazi Sabbir
    Abstract: The public expenditure allocation in Bangladesh has played a substantial role in improvements of physical infrastructure, health, education, community development, etc. during the recent decades. There have been allegations that inequality in the distribution of political power has often led to some extent to a disproportionate public spending, which in turn may hinder prospects of poverty reduction. The current study aims to examine the research question of whether regional inequality issues are properly addressed within the framework of the public expenditure allocation in Bangladesh during the recent years and if not, whether this has been influenced by some other considerations, which are mainly political by nature. We analyze a panel data set where the dependent variable is the (greater district) per capita ADP allocation within a sector and the independent variables are some explanatory variables, and a variable of interest measuring the proportion of the total number of constituencies within the greater district that belongs to the political party in power. In summary, the study provides evidence of some in-built regional inequality features within the public expenditure allocation in Bangladesh in association with the political favoritism issues involved in a supposedly parliamentary democratic system.
    Keywords: Public Expenditure; Regional Inequality; Political Influence in Regional Distribution of Public Expenditure; Panel Data
    JEL: H72 H5 H76 C33
    Date: 2008–03–13
  15. By: Leszek Morawski; Michal Myck (Institute for Fiscal Studies and DIW-Berlin)
    Abstract: <p>In 2007 and 2008 Polish governments introduced a series of reforms which led to a substantial reduction in the tax "wedge" (in Polish: "klin") on labour. The mean ATR on total labour cost was reduced from 41.6% to 34.0%. We show that when considered together the package of introduced reforms brought much greater reductions in the tax burden compared to a widely discussed 15% "flat tax". In the analysis we show the effects of the reforms both for the employed and for the non-employed populations. The latter analysis is done in such a way as to account for the entire (simulated) distribution of wages of the non-employed and shows interesting differences between the effects of reforms on employed and non-employed individuals. We argue that to fully appreciate the effect of reductions in labour taxation it is important to bear in mind that one of the reasons for introducing them is to make employment more likely for those who currently do not work. Given the extent of the reductions in the "klin" it is somewhat surprising that so far so little attention has been given to the recent Polish reforms. </p>
    Keywords: Work incentives, tax wedge, labour costs, employment
    JEL: H24 J21 J31
    Date: 2008–11
  16. By: Christopher Cotton (Department of Economics, University of Miami)
    Abstract: This paper develops a model of political contributions in which a politician can either sell policy favors, or sell access. Access allows interest groups to share hard information with the politician in support of their preferred policy. Here selling access maximizes policy utility, while selling policy favors maximizes total contributions. Imposing a binding contribution limit makes it more likely that the politician sells access, which can improve expected constituent welfare. However, a contribution limit distorts the signals associated with the contributions, which tends to result in worse policy. Alternatively, a tax on political contributions can ensure that the politician sells access without distorting his information. Therefore, from the viewpoint of a representative constituent, a tax on contributions is strictly preferred to a contribution limit or no reform. The politician, however, may prefer regulation in the form of a contribution limit, even when a tax is better for the constituent.
    Keywords: Lobbying, campaign ï¬nance reform, political access, bid caps, verfiable information, evidence disclosure
    JEL: D72 D44 D82 D78
    Date: 2008–12
  17. By: James M. Sallee
    Abstract: A variety of state and federal tax incentives have been used to subsidize gas electric hybrid vehicles. In this paper, I estimate the incidence of these tax incentives using microdata on sales of the Toyota Prius, in order to determine who benefits from these policies. I focus on three sharp changes in federal subsidies stemming from the Energy Policy Act of 2005 and assemble several pieces of evidence which indicate that consumers captured nearly all of the benefit. First, subsidy exclusive transaction prices do not jump in the anticipated direction in response to large changes in federal tax incentives. Second, estimates that account for consumer heterogeneity indicate that consumers captured the majority of the gains. Third, a state panel regression on state tax incentives shows that state tax incentives have little or no effect on transaction prices, which is consistent with the federal result. The conclusion that consumers captured the subsidy poses a challenge to standard models of tax incidence. Toyota faced a binding capacity constraint when the credit was introduced. Given a fixed supply, standard models predict that Toyota would capture the subsidy. I argue that consumers gained instead because Toyota believed that raising prices to clear the market would lower future demand for hybrids. I outline a stylized model in which current prices influence future demand and show that a capacity constraint can generate the tax incidence observed in the data. I then discuss factors that could give rise to such a demand system, drawing on the theory of search among alternatives and the behavioral literature on fairness. Finally, I draw lessons for the study of tax incidence in other markets.
    Keywords: hybrid vehicles, tax credit, tax incidence,
    Date: 2008–12
  18. By: Dahlby, Bev (University of Alberta, Department of Economics)
    Abstract: Does democracy lead to the creation of too many municipalities? We analyze this issue within the context of the Alesina and Spolare (1996) model where the quality of municipal services deteriorates with the distance from the center of a municipality. Individuals can vote in a referendum to split an existing municipality. We show that social welfare will decline when municipalities are split if the level of the public service, as chosen by the median voter, is lower in the new smaller municipalities. In general, the model indicates that there may be a democratic bias in favour of creating too many municipalities.
    Keywords: median voter model; fiscal federalism; succession; municipal boundaries
    JEL: H71 H72 H77
    Date: 2009–02
  19. By: Murphy, Alan P. (Central Bank and Financial Services Authority of Ireland)
    Abstract: This paper tests to what extent are corporate tax differentials motivating the reallocation of reported profits between EU parent multinationals and their European based affiliates. Hines and Rice (1994) report that a 1-percentage point reduction in corporation tax induces a 3% rise in reported profitability of European based affiliates of US parent multinationals. When aggregated firm-level tax data are used and do not directly control for the parent-affiliate pair-wise trading environments, we obtain a semi-elasticity of -2.4 that is similar to previous research. But when we apply firm-level information on the total bundle of tax liabilities and control for the trading environment of each parent-affiliate pair we obtain a semi-elasticity of –0.25. This suggests that while corporation tax differences do affect reported profitability; the magnitude of this effect is lower than previously reported in studies using information from U.S. owned multinationals.
    Date: 2009–03
  20. By: Thomas Crossley (Institute for Fiscal Studies and University of Cambridge); Hamish Low (Institute for Fiscal Studies and Trinity College, Cambridge); Matthew Wakefield (Institute for Fiscal Studies and University College London)
    Abstract: <p><p>1. The rate of VAT has been cut temporarily to 15%, with a return to 17.5% in place for the end of 2009. The government has predicted that this will increase consumer spending by about 0.5%. Much of the analysis of this tax cut has been critical of the policy and concluded that the government's estimates of the impact on spending are over-optimistic. The source of this criticism is a misunderstanding of the mechanism through which the tax cut will have an impact. In fact, we believe the government's estimates are overly-pessimistic. </p><p> </p><p></p><p>2. There are two mechanisms through which the temporary VAT cut might affect spending: </p><p></p><p>first, it will increase spending power, making households feel as if they have more income. This mechanism is likely to be small partly because the tax cut increases income only for one year, and so the increase in total lifetime resources is very small, and partly because the lost revenue will have to be paid back. </p><p> </p><p></p><p>3. However, the second (often ignored) mechanism is likely to be much more important. This second mechanism is the effect that the tax cut will have through changing the price of goods bought in 2009 compared to 2010: the cost of goods bought in 2009 has fallen compared to goods bought in 2010 and this change in prices gives an incentive to bring forward consumer spending to this year, rather than waiting until next. </p><p> </p><p></p><p>4. Economic evidence on households' willingness to move spending from one year into an earlier (or later) year suggests that a 1% fall in the price today will translate into a 1% increase in spending. Since roughly only half of goods purchased are subject to VAT, the cut in the rate by 2.5% is like a cut in prices today by 1.25% and we would expect this to boost spending by about 1.25% over what it would otherwise be. </p><p> </p><p></p><p>5. Of course, this issue of what the spending would otherwise be is crucial: we will not now know what spending in 2009 would have been without the cut in VAT and even with the VAT cut, spending is likely to decline. Our point is simply that economic analysis shows that the cut in VAT will make the situation significantly less bad than it might otherwise have been. </p><p> </p><p></p><p>6. A natural comparison to the fiscal stimulus of a cut in VAT is a monetary stimulus through a cut in the interest rate: both make the price of spending today low compared to next year - an interest rate cut makes saving less attractive than current spending, as does the cut in VAT. The 1.25% fall in prices due to the cut in VAT reduces the price of spending today by more than a 1% point cut in the interest rate. It is surprising that some commentators have labeled the former as "small", while the latter would typically be considered a large cut. </p><p> </p><p>7. There is however a difference between cutting interest rates and cutting VAT: a cut in interest rates penalises savers, whose spending power falls, and rewards borrowers. By contrast, the cut in VAT increases the spending power of savers (as well as borrowers) and this seems a fairer way to stimulate the economy.</p></p>
    Date: 2009–01

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