Tax competition and tax coordination in a median voter model

This paper analyzes the welfare effects of capital tax coordination in a si mple model of fiscal competition where fiscal policy is subject to majority voting and households differ with respect to their labor and capital incom e. It turns out that a coordinated capital tax increase may raise or reduce welfare, depending on the relative magnitude of i) economic distortions in duced by a labor tax and ii) political distortions resulting from the influ ence of the median voter on fiscal policy decisions. A negative welfare eff ect is more likely, the smaller the marginal excess burden of the labor tax and the smaller the ratio of the median voter's labor income to average la bor income. We also use empirical estimates of the marginal excess burden o f taxation to determine the welfare effects of tax coordination; it turns o ut that a negative welfare effect of coordinated tax increases may emerge i n our model for empirically reasonable parameters.