Tax policy coordination, vertical externalities, and optimal taxation in asystem of hierarchical governments

Tax policies of two levels of government (state and federal) with overlappi ng tax bases are considered. This overlap leads to "vertical" fiscal extern alities are considered when several different commodities are in the tax ba se and the tax bases of the two levels of government may not be identical. When the governments share a tax base, the mix of combined taxes is optimal . With different tax bases, combined taxes are no longer optimal as federal tax rates are adjusted to reflect state public service levels. When grants are available, a welfare-maximizing mix of taxes and public services is ob tained. (C) 2001 Academic Press.