Interjurisdictional Capital Mobility: Fiscal Externality and a Corrective Subsidy
David E. Wildasin Department of Economics Indiana University Bloomington, IN 47405 USA
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.