We develop a theory of cross-border income shifting in response to subnational personal taxation in a federation and examine its implications for the excess burden of personal taxes. We show how a properly chosen federal tax rate can offset the fiscal externality between states and facilitate decentralization, even in a heterogeneous federation where unitary taxation is suboptimal. Optimal taxes depend on the elasticities of national tax avoidance and of cross-state tax base shifting. We estimate these elasticities around a tax decentralization reform in Canada, finding both to be empirically relevant. We discuss the implications for optimal federalism.
"An Estimable Model of Income Redistribution in a Federation: Musgrave Meets Oates."
American Economic Journal: Economic Policy,
Personal Income, Wealth, and Their Distributions
Taxation and Subsidies: Efficiency; Optimal Taxation
Taxation and Subsidies: Externalities; Redistributive Effects; Environmental Taxes and Subsidies
Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
Tax Evasion and Avoidance
State and Local Taxation, Subsidies, and Revenue
Intergovernmental Relations; Federalism; Secession