VERTICAL TAX EXTERNALITIES IN THE THEORY OF FISCAL FEDERALISM

Federal structures create the possibility of vertical tax externalitie s between levels of government, with the private sector's response to the tax policy decisions of one level affecting the tax base of the ot her. Such effects arise most obviously when both levels of government co-occupy the same tax base. This paper reviews and extends resent res ults on the implications of such externalities for the relationship be tween state and federal tar rates, the equilibrium levels of these tax es, the (ir)relevance of experience in federal countries for analyzing international tax issues, the pattern of intergovernmental grants, an d the assignment of tax powers. [JEL H3, H7, H21].