Risk-Pooling vs. Rent Capture

David E. Wildasin
Department of Economics
Vanderbilt University
John Douglas Wilson
Department of Economics
Indiana University

When a jurisdiction's land or other fixed resources are owned by non-residents, its residents have an incentive to impose confiscatory taxes in order to capture rents from outsiders. Under certainty, such taxes redistribute rents but impose no efficiency loss. When  different jurisdictions are subject to less than perfectly correlated risks, however, such taxes destroy the benefits of risk-pooling that cross-ownership of property would permit.  If jurisdictions are constrained to use property taxes (i.e., taxes on both immobile land and mobile capital) instead of taxes on land alone, they have an incentive to limit their taxes in order not to discourage capital investment. If capital is sufficiently substitutable for immobile factors, jurisdictions will choose low property tax rates in order not to drive away mobile capital, resulting in greater effective diversification of risks and higher welfare.

David E. Wildasin / dew@davidwildasin.us