Abstract
This paper concerns income- and production taxation in a decentralized fiscal federalism model where the ability to commit differs among member countries. It is assumed that the federal government dictates environmental targets to be implemented at the national level, where the horizontal leader has commitment power vis-à-vis the other country (the follower). The results show how incentives underlying the horizontal leader’s tax policies are influenced by the decision structure.
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Notes
Channels from a higher (federal) level government to a lower level government (member state) are typically denoted vertical, while channels at the same level are denoted horizontal.
It is rather straightforward to introduce other types of horizontal interactions such as e.g. labor mobility which would potentially give rise to strategic actions across member states.
In most literature dealing with decentralized fiscal federlism there is an underlying assumption of Nash competition at country level.
The price of good \(x\) is treated as exogenous at both the federal- and national level.
The sector specific production factor—introduced to avoid fixed wages—will be suppressed for notational convenience throughout the paper. It is implicitly assumed that the sector specific factor is owned by the domestic government.
To focus on the interactions via the environmental damage and targets, other potential issues such as labor mobility have been discarded. The mechanisms found in the present setup would however still remain.
Note that, since the environmental damage is linear in the bad input, \(e^{i}\) equals the use of bad input, \(b^i\).
The reason is that, although the leader may influence the production tax, \(t^{2}\), it only affects \(b^{2}\left( \cdot \right) \) which, in the end, must be determined by the environmental target level. Therefore, a constraint reflecting horizontal leadership via \(t^{2}\) would become redundant in this specific setup.
In a noncooperative Nash equilibrium the production tax reduces to this term.
According to the full first order conditions for the environmental targets (equilibrium conditions have been used in Eq. 7), there are, however, additional effects arising from a change in the hours of work. This makes the total effect on the use of the bad input ambiguous.
The notation follows the previous cases where \(e^{i}=E^{i}\).
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Acknowledgments
The author would like to thank Thomas Aronsson and Tomas Sjögren for helpful comments and suggestions.
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Research grants from FORMAS, the Bank of Sweden Tercentenary Foundation, the Swedish Council for Working Life and Social Research, and the Swedish Tax Agency are gratefully acknowledged.
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Persson, L. Incentives underlying tax policies in a decentralized federation with horizontal leadership and transboundary environmental damage. Lett Spat Resour Sci 8, 77–88 (2015). https://doi.org/10.1007/s12076-014-0123-1
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DOI: https://doi.org/10.1007/s12076-014-0123-1