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“Dynamic Tax Externalities and the U.S. Fiscal Transformation,” JME

Summary:
Accepted for publication in the Journal of Monetary Economics, with Martin Gonzalez-Eiras. PDF. (Appendix: PDF.) We propose a theory of tax centralization in politico-economic equilibrium. Taxation has dynamic general equilibrium implications which are internalized at the federal, but not at the regional level. The political support for taxation therefore differs across levels of government. Complementarities on the spending side decouple the equilibrium composition of spending and taxation and create a role for inter governmental grants. The model provides an explanation for the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, it accounts for approximately 30% of the federal revenue

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Accepted for publication in the Journal of Monetary Economics, with Martin Gonzalez-Eiras. PDF. (Appendix: PDF.)

We propose a theory of tax centralization in politico-economic equilibrium. Taxation has dynamic general equilibrium implications which are internalized at the federal, but not at the regional level. The political support for taxation therefore differs across levels of government. Complementarities on the spending side decouple the equilibrium composition of spending and taxation and create a role for inter governmental grants. The model provides an explanation for the centralization of revenue, introduction of grants, and expansion of federal income taxation in the U.S. around the time of the New Deal. Quantitatively, it accounts for approximately 30% of the federal revenue share’s doubling in the 1930s, and for the long-term increase in federal grants.

Dirk Niepelt
Dirk Niepelt is Director of the Study Center Gerzensee and Professor at the University of Bern. A research fellow at the Centre for Economic Policy Research (CEPR, London), CESifo (Munich) research network member and member of the macroeconomic committee of the Verein für Socialpolitik, he served on the board of the Swiss Society of Economics and Statistics and was an invited professor at the University of Lausanne as well as a visiting professor at the Institute for International Economic Studies (IIES) at Stockholm University.

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