Tax competition with two mobile and interdependent tax bases: which fiscal architecture ?
Our paper analyses the issue of fiscal architecture from a tax competition perspective, in a two-tier setting with multiple countries and regions. Considering two mobile and interdependent tax bases allows us to compare four fiscal architectures: i) full decentralization, ii) full centralization, iii) partial decentralization with shared tax bases and iv) partial decentralization with exclusive tax bases. The interdependence between the two tax bases generates "indirect" tax externalities and reinforces the standard "direct" tax externalities. It results in partial decentralization with exclusive tax bases differing from other fiscal architectures in that tax competition can lead to inefficiently high tax rate at either tier. While there is always a level of expenditure decentralization such that partial decentralization with shared tax bases dominates full centralization, this is no longer the case with exclusive tax bases, which even leads to the lowest welfare for a sufficiently high degree of substitutability between the tax bases.