The consequences of overlapping tax bases for redistribution and public spending in a federation

Tax and expenditure policies are studied in a federation with imperfectly mobile households. States implement a linear progressive tax and supply a public good. A vertical fiscal externality, reflecting the effect of state policies on federal revenues, provides an incentive for state taxes to be too progressive. A horizontal fiscal externality causes nonoptimal state taxes and expenditures because of the migration effect. The federal government implements its own Linear progressive tax and makes transfers to the states. The federal government can nullify both externalities by appropriate fiscal policies, and redistributive taxation can be decentralized to the states. (C) 1998 Elsevier Science S.A.