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

Fidel Perez-Sebastian, Ohad Raveh*, Yaniv Reingewertz

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

2 Scopus citations


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.

Original languageAmerican English
Pages (from-to)85-110
Number of pages26
JournalJournal of Urban Economics
StatePublished - Jul 2019

Bibliographical note

Funding Information:
Fidel Perez-Sebastian thanks Ministerio de Economía y Competitividad and Fondo Europeo de Desarrollo Regional (ECO2015-70540-P MINECO/FEDER), and the Generalitat Valenciana ( PROMETEO/2013/037 ) for financial support. We thank seminar participants at the Hebrew University of Jerusalem, Tel-Aviv University, University of Alicante, University of Oxford, the 2016 American Economic Association Conference, the 2015 Israeli Economic Association Conference, the 2015 Public Choice Society Conference, and the 2016 SURED Conference, as well as to Ziv Bar-Shira, Robin Boadway, Israel Finkelshtain, Moshe Hazan, Morten Ravn, Gerhard Toews, Rick van der Ploeg, and Tony Venables, for helpful comments and suggestions. Finally, we are grateful to Brock Smith and James Snyder for sharing helpful data. The paper circulated previously under the title ”Heterogeneous Vertical Tax Externalities, Capital Mobility, and the Fiscal Advantage of Natural Resources”.

Publisher Copyright:
© 2019 Elsevier Inc.


  • Federalism
  • Fiscal advantage
  • Natural resources
  • Tax competition


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