The efficiency of state taxes on mobile labour income

We model a federation where States levy a tax on the wage income of mobile citizens who shop between States for their preferred tax and public policy package. It is shown that competition between States results in efficient S tate spending but that the taxes on wage income are inefficient in the sens e that mobile taxpayers are allocated inefficiently across States. The impl ication is that if States tax the wage income of mobile workers, there may be benefits from policy competition (a more competitive federal system) but also costs associated with the inefficiency. The central government can co rrect for the inefficiency, but this requires a complex system of inter-Sta te transfers that are difficult to implement in practice.