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Heterogeneous vertical tax externalities and macroeconomic effects of federal tax changes: the role of fiscal advantage

Perez-Sebastian, Fidel; Raveh, Ohad; Reingewertz, Yaniv


Fidel Perez-Sebastian

Ohad Raveh

Yaniv Reingewertz


How do state tax rates respond to federal tax shocks? This paper presents a novel mechanism of heterogeneous vertical tax externalities across state-levels of fiscal advantage, showing that tax increases can be expansionary even without their reinvestment. States rich in natural resources have a fiscal advantage in the inter-state competition over production factors which allows them to respond better to increases in federal taxes and, consequently, attract capital from other parts of the nation. We add heterogeneity in fiscal advantage levels to an otherwise standard model of vertical tax externalities and horizontal tax competition. The model shows that, irrespective of federal redistribution, the contractionary effect of a federal tax increase can be overturned in fiscally advantaged states, through an increase in their tax base. Using the case of the U.S., and narrative-based measures of federal tax shocks a-la Romer and Romer (2010), we provide empirical evidence for the various aspects of this mechanism. Specifically, our baseline estimates indicate that, controlling for federal transfers, a 1% increase in the GDP share of capital-related federal taxes at the beginning of a year increases the growth rate of the per capita tax base by approximately 0.7% in high fiscal advantage states at the end of it.


Perez-Sebastian, F., Raveh, O., & Reingewertz, Y. (2019). Heterogeneous vertical tax externalities and macroeconomic effects of federal tax changes: the role of fiscal advantage. Journal of urban economics, 112, 85-110.

Journal Article Type Article
Acceptance Date Jun 3, 2019
Online Publication Date Jun 4, 2019
Publication Date 2019-07
Deposit Date Jun 4, 2019
Publicly Available Date Jun 5, 2021
Journal Journal of Urban Economics
Print ISSN 0094-1190
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 112
Pages 85-110
Keywords Federalism; Natural resources; Fiscal advantage; Tax competition
Public URL
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