Scandinavian Working Papers in Economics

Umeå Economic Studies,
Umeå University, Department of Economics

No 573: Testing for Vertical Fiscal Externalities

Linda Andersson (), Thomas Aronsson () and Magnus Wikström ()
Additional contact information
Linda Andersson: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden
Thomas Aronsson: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden
Magnus Wikström: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden

Abstract: The purpose of this paper is to design a test of whether the vertical external effects associated with tax base sharing among local and regional governments have become internalized via the intergovernmental transfer system. Such tests are important in the sense that the income tax rates chosen by different levels of government will generally be correlated, even if the resource allocation is optimal from society's point of view. By using panel data for the Swedish local and regional public sectors, the results imply that an increase in the regional income tax rate induces the municipalities in the region to decrease their income tax rates. In addition, we are able to reject the null hypothesis that the vertical external effects have become internalized.

Keywords: Local and regional governments; optimal taxation; vertical external effects

JEL-codes: D62; H21; H23

26 pages, November 9, 2001

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