In economies with multi-level governments, why would a change in the fiscal rule of a government in one level lead to a fiscal response by a government in a different level? The literature focused primarily on the standard common-pool problem, while giving little attention to the potential role of complementarity or substitutability (CS) between the public goods supplied by the two governments. This paper fills this gap by focusing on the latter channel. First, we illustrate its potential key role in determining the sign of the vertical reaction through a generic model of vertical fiscal interactions. Second, we propose a novel strategy for identifying it, by considering an empirical design that confines the common-pool channel to specific locations. We implement this design through a quasi-natural experiment: the 1980 U.S. Crude Oil Windfall Act, which increased federal tax collections from sale of crude oil, thereby affecting the tax base of oil rich states specifically. This latter feature enables attributing the vertical fiscal reactions of the remaining states to the CS channel. Following this strategy, via a difference-in-differences approach, we decompose the sources of the vertical fiscal reactions arising from this federal tax change and find that those attributed to the CS channel: (i) account for approximately 38% of the overall vertical fiscal response; (ii) point at complementarity between state and federal public goods, most notably in transportation and welfare expenditures; (iii) are manifested primarily via changes in states' sales and income taxation.
|Original language||American English|
|Number of pages||18|
|Journal||Regional Science and Urban Economics|
|State||Published - Nov 2018|
Bibliographical noteFunding Information:
We thank David Agrawal, Ziv Bar-Shira, Thushyanthan Baskaran, Julie Cullen, Israel Finkelshtain, Yaniv Reingewertz, Gerhard Toews, Tony Venables, and seminar participants at the Bank of Israel, Hebrew University of Jerusalem, and University of Oxford for helpful comments and suggestions. We acknowledge outstanding research assistance by Mark Rozenberg, and Maayan Segev. Raveh gratefully acknowledges financial support from the Center for Agricultural Economic Research. Perez-Sebastian gratefully acknowledges financial support from Ministerio de Economıa y Competitividad and Fondo Europeo de Desarrollo Regional (ECO2015-70540-P MINECO/FEDER). All errors are our own. The paper circulated previously under the title: “On the Role of State-Federal Complementarities in Vertical Tax Externalities: Evidence from the 1980 Crude Oil Windfall Act”.
© 2018 Elsevier B.V.
- Common-pool problem
- Natural resources
- Vertical fiscal reactions