Conference on Fiscal Federalism.

The NBER and the CESifo in Munich co-sponsored a Conference on Fiscal Federalism on May 20-22 in Munich. The conference, part of a series of Trans-Atlantic Public Economics Seminars, was organized by Roger H. Gordon, NBER and University of California, San Diego. The following papers were discussed:

Mihir A. Desai, NBER and Harvard University, and C. Fritz Foley and James R. Hines, Jr., NBER and University of Michigan, "Economic Effects of Regional Tax Havens"

Discussants: Roger H. Gordon, and Federico Revelli, University of Turin 

Kurt Schmidheiny, Universite de Lausanne, "Income Segregation and Local Progressive Taxation: Empirical Evidence from Switzerland"

Discussants: Hans-Werner Sinn, NBER and University of Michigan, and Katherine Baicker, NBER and Dartmouth College

Thiess Buettner, Mannheim University, "Incentive Effects of Fiscal Equalization Transfers on Tax Policy"

Discussants: Helmuth Cremer, University of Toulouse, and James M. Poterba, NBER and MIT 

Federico Revelli, "Performance Rating and Yardstick Competition in Social Service Provision"

Discussants: James R. Hines, Jr., and Jean Hindriks, Catholic University of Louvain

Dennis Epple and Holger Sieg, NBER and Carnegie Mellon University; Stephen Calabrese, University of South Florida; and Thomas Romer, Princeton University, "Myopic Voting and Local Public Good Provision: Theory and Evidence"

Discussants: Soren Blomquist, Uppsala University, and Tim Besley, NBER and Stanford University

Martin Farnham, University of Michigan, and Purvi Sevak, Hunter College, "State Policy and Local Residential Sorting: Are Tiebout Voters Hobbled?"

Discussants: Michelle J. White and Nora Gordon, NBER and University of California, San Diego

Clemens Fuest, University of Cologne, and Bernd Huber, University of Munich, "Can Regional Policy in a Federation Improve Economic Efficiency?"

Discussants: Vesa Kanniainen, University of Helsinki, and John Burbidge, McMaster University

Katherine Baicker and Nora Gordon, "Do State and Local Governments Use Other Public Expenditures Programs to Undo the Redistribution of Court-Ordered School Finance Equalization?"

Discussants: Holger Sieg, and Julia Darby, University of Strathclyde 

Julia Darby; and Anton Muscatelli and Graeme Roy, University of Glasgow, "Fiscal Federalism and Fiscal Consolidations: Evidence from an Event Study"

Discussants: Dennis Epple and Thiess Buettner

Katherine Cuff, John Burbidge, and Jack Leach, McMaster University, "Capital Tax Competition with Heterogeneous Firms"

Discussants: Luca Micheletto, Bocconi University, and Clemens Fuest

Jacob L. Vigdor, Duke University, "Median Voters, Nonresidents, and Property Tax Limitations"

Discussants: Brian Knight, University of Greenwich, and Martin Farnham

Jacques Dreze, CORE; Charles Figuieres, University of Bristol, and Jean Hindriks, "Voluntary Matching Grants"

Discussants: Alexander Plekhanov, Cambridge University, and Jacob L. Vigdor

Using affiliate-level data, Desai, Foley, and Hines analyze the impact of tax haven operations on the non-haven activities of American multinational firms. The evidence implies that American firms use tax haven affiliates both to reallocate taxable income away from high-tax jurisdictions and to facilitate deferral of repatriation taxes, particularly from low-tax jurisdictions. Ownership of tax haven affiliates reduces tax payments by nearby non-haven affiliates to the same degree as would a 21 percent reduction in the local tax rate. While havens facilitate profit reallocation and deferral of repatriation taxes, they may also reduce the cost of capital and thereby increase the attractiveness of foreign investment in non-havens. The evidence indicates that firms with non-haven operations in countries whose economies grow rapidly are the most likely to establish new tax haven affiliates, implying a complementary relationship between haven and nonhaven operations, and the potential for tax haven jurisdictions to contribute to regional economic growth.

Schmidheiny investigates spatial segregation of the population in fiscally decentralized urban areas. The theoretical part of his paper proposes the progressivity of local income taxes as a new explanation for income segregation. The empirical part studies how income tax differentials across communities affect households' location decisions. The data from the Swiss metropolitan area of Basel contain tax information from all households that moved, either within the city center of Basel or from the city center to the outskirts. The empirical results show that rich households are significantly and substantially more likely to move to low-tax communities than poor households.

A theoretical analysis gives rise to the presumption that, in the presence of tax competition, a system of redistributive "fiscal equalization" transfers tends to raise the taxing effort of local jurisdictions. More specifically, Buettner shows that the marginal contribution rate, that is the rate at which an increase in the tax base reduces those transfers, might be positively associated with the local tax rate. This is partly confirmed in an empirical investigation based on a large panel of German municipalities. In particular, changes in the marginal contribution rate attributable to changes in the rules of the system exert a significant positive impact on the local tax rate.

Revelli investigates whether national evaluation of decentralized government performance, by lessening local information spill-overs, tends to reduce the scope for local performance comparisons and consequently to lower the extent of spatial auto-correlation among local government expenditures. He analyzes U.K. local government expenditures on personal social services before and after the introduction of a national performance assessment system that attributes a rating to each local authority. The empirical evidence suggests that the introduction of the social services performance assessment system has substantially reduced policy mimicking among neighboring jurisdictions.

There have been few empirical strategies developed to investigate public provision under majority rule while explicitly accounting for the constraints implied by households' mobility. Most previous empirical work has focused on necessary conditions that the observed expenditures, housing prices, and tax rates had to satisfy in a myopic voting equilibrium. The existing empirical evidence suggests that myopic voting behavior is not consistent with the data. This is puzzling, especially given the prominence that myopic voting plays in the theoretical literature. Calabrese, Epple, Romer, and Sieg develop a new empirical approach that allows them to impose all restrictions that arise from these equilibrium models simultaneously on the data generating process. They can then analyze how close myopic models come in replicating the main regularities about expenditures, taxes, sorting by income, and housing observed in the data. The main results suggest that myopic models can replicate the observed expenditure patterns as well as the observed sorting of households by income. However, these models cannot fit the observed tax rates.

While the Tiebout hypothesis has come under increasing empirical fire, studies have not convincingly ascertained whether weak Tiebout sorting is truly evidence against the hypothesis or simply evidence that the prevalence of centralized state policies removes the conditions necessary for fiscal sorting. Farnham and Sevak explore the extent to which state fiscal policy pertaining to the school finance system affects the incentive or ability to sort on local fiscal characteristics. Using panel data on older households from the Health and Retirement Study, the authors find smaller adjustments of the local fiscal bundle by within-state empty-nest movers in the presence of school finance equalization policies. In addition, they use household data from the 1970-2000 decennial census to analyze differences in within-state and cross-state mobility rates and location choice under different school finance regimes. They find evidence of decreased within-state mobility at critical points in the Tiebout lifecycle when school finance equalization is present. They also find evidence that older households may escape centralization by moving across state lines.

In the European Union and in many federal and non-federal countries, the central government pays subsidies to poor regions. These subsidies often are seen as a redistributive measure which comes at the cost of an efficiency loss. Fuest and Huber develop an economic rationale for regional policy based on economic efficiency. They consider a model of a federation consisting of a rich and a poor region. The economy is characterized by increasing returns to scale in production and imperfect competition in goods markets. Firms initially only produce in the rich region and may set up additional production facilities in the poor region or serve this region via exports, which gives rise to a transport cost. The authors show that the laissez faire allocation is characterized by too little mobility; that is, the number of firms investing in the poor region and the number of households migrating to the rich region is inefficiently low. The optimal regional policy subsidizes investment and supports mobility of households in the poor region. These results also hold if there are autonomous regional governments.

Many states are under court-order to reduce local disparities in education spending. When states spend more on education, that changes both state and local budget constraints, and thus may affect many different spending and revenue decisions. Baicker and Gordon examine how changes in state education spending affect the level and distribution of the total resources available to localities and spending on public goods--both through changes in state spending patterns and through changes in the revenue and spending decisions of local jurisdictions themselves. The authors find that mandated school finance equalizations do increase both the level and progressivity of state spending on education, but that states finance the required increase in education spending in part by reducing their aid to localities for other programs. Local governments, in turn, respond to the increases in state taxation and spending by reducing both their own revenue-raising and their own spending on education and other programs. Thus, while state education aid does increase total spending on education, it does so at the expense of drawing resources away from spending on programs like public welfare, highways, and hospitals.

Darby, Muscatelli, and Roy investigate the use of grants and shared tax revenues, and their impact on fiscal outcomes, including decentralized service provision. They use a panel dataset covering 15 OECD countries to investigate how central and sub-central expenditures, taxation, and intergovernmental grants change in response to central governments' attempts to correct their fiscal positions. Their key results can be summarized as follows: first, successful fiscal consolidations are generally driven by similar, and sustained, falls in expenditure at both central and sub-central tiers. Moreover, the evidence counters Gramlich (1987) in the United States: when central governments cut intergovernmental grants, sub-central tiers do not take redress through offsetting increases in other forms of revenues. Second, unsuccessful consolidations tend to be characterized by increased central government taxation, with no fall back in grants and no tendency for sub-central taxation to change. There does appear to be a strong correlation between success in consolidating central fiscal deficits and similar actions from lower tiers of government. Third, where consolidations are successful, sub-central tiers of government are typically forced to cut back on capital expenditure. This suggests that the burden of adjustment falls onto lower tiers of government; and central governments worry less about the long-term (that is, public investment) consequences of consolidation if these decisions are taken at local level. Also, when faced with cuts in intergovernmental grants, sub-central governments tend to maintain expenditures on wages at the expense of capital expenditure, reflecting a definite compositional switch towards public consumption. Finally, these results shed some light, at least indirectly, on the "Fly-paper Effect," by showing that it operates in reverse. Successful consolidations are characterized by cut-backs in grants that are more than offset by cut-backs in sub-central expenditures. In contrast, periods of unsuccessful consolidation are characterized by increases in central taxation, no change in grants, and small, temporary reductions in sub-central expenditure.

Burbidge, Cuff, and Leach extend the capital tax competition literature by incorporating heterogeneous capital and agglomeration. Their model nests the standard tax competition model as well as the special case in which there is agglomeration but no firm/capital heterogeneity and the opposite case, firm heterogeneity with no agglomeration. The authors build on the existing tax competition literature and establish a link between it and the more recent work on agglomeration using the new economic geography model.

Why would voters resort to a statewide tax limitation to force change in their own local government? Vigdor develops and tests the hypothesis that property tax limitations succeeded because they allowed voters to lower tax rates in other communities. Statewide limitations effectively extend the voting franchise to individuals who have no standing in local elections. Voters may have preferences for tax and expenditure levels in other jurisdictions because they receive rents from employment in those jurisdictions, directly own taxable assets in those jurisdictions, or because changes in other jurisdictions might influence their own residential location choice. Empirical tests of this hypothesis focus on the Massachusetts experience with Proposition 2 1/2, which passed in 1980. Voting patterns, household mobility patterns, and post-Proposition growth in property values all support the nonresident hypothesis.

Dreze, Figuieres, and Hindriks investigate the possibility of achieving by means of voluntary matching grants both the optimal allocation of factors and the optimal level of redistribution in the presence of factor mobility. They use a fiscal competition model in which states differ in their technologies and preferences for redistribution. They derive the optimal differentiation of matching rates across states according to the asymmetries in the technology and in the redistribution motive. Then they derive the willingness of each state to match the contribution of other states, and decompose the aggregate willingness to pay as the sum of two terms. The first term is related to redistribution; it is positive only if matching the contribution of one state brings overall redistribution closer to its optimal level. The second term is related to production; it is positive if the matching to one state leads to a more efficient allocation of factors. Willingness to pay for matching rates converges to zero when both the optimal level of redistribution and the optimal allocation of factors are achieved. The authors then describe the adjustment process for the matching rates that will lead agents to the efficient outcome and guarantee that everyone will gain.