Fiscal federalism revisited (Q1581191)

This paper analyses the conditions under which fiscal harmonization between, say, taxes levied at the Federal and at the Provincial level is desirable. When the Federal Government can levy taxes on all commodities, there is no benefit from fiscal harmonization as the economy operates on its efficiency frontier. However, this result is not true when the Federal Government can levy taxes on only a subset of commodities, and there is a production efficiency gain from tax harmonization. This latter case can arise if, for instance, some of the taxes the Federal Government would like to levy are at or below zero (assuming away the possibility of subsidies, i.e. negative taxes, which would correspond to revenue sharing between the two governments). By controlling taxes, the Federal Government is controlling indirectly consumer prices. Is the previous result true when the Federal Government controls directly prices rather than taxes? The answer is negative: if the Federal Government can control directly a subset of commodity prices, there is no productivity efficiency gains from fiscal harmonization. This last result shows that the often-used-in-practice procedure of looking at price distortion to infer tax distortion is misleading.