Recent studies emphasize that local property taxation may result in inefficiently small amounts of local public spending. This paper shows that the inefficiency can be traced to a fiscal externality: when one jurisdiction increases its taxes, it causes a flow of capital to other jurisdictions that increases their tax revenues. The inefficiency can be corrected with a subsidy that internalizes the externality. Key empirical parameters determining the magnitude of the externality are identified. Illustrative calculations indicate that subsidy rates on the order of 40% might be required to achieve efficiency.

David E. Wildasin / dew@davidwildasin.us