The paper deals with vertical tax competition between self-interested gover
nments in a dynamic environment. In a federation, competition between the f
ederal and the state governments arises when tax sources are not separated
but pooled. Since dynamic inefficiencies will be stressed, the focus is on
fiscal stock externalities rather than on flow externalities. The paper sho
ws that the Leviathans in a federation tax the fiscal common resource more
extensively than the single Leviathan in a unitary state. Furthermore, the
positive impact of political stability on public consumption of the fiscal
common will be discussed.