An Empirical Test of the Dominant Tax Externality in Sweden

We empirically reexamine the dominance of tax externalities in Sweden for the period of 2000through 2011. Where hierarchical governments share a mobile tax base, a tax externality canarise not only horizontally across the same level of government but also vertically betweendifferent levels of government. A horizontal externality shifts tax rates toward a level that istoo low, whereas a vertical externality pushes them toward a level that is too high. The netoutcome of these competing effects is theoretically unclear within benevolent federalgovernment systems. Brülhart and Jametti (2006) implemented a pioneering empirical test ofthe issue using Swiss data. Their empirical setting, however, assumes a single tax instrument,which contradicts the fiscal system in Switzerland. This inconsistency would theoreticallydistort their estimation. By contrast, our study investigates the pure dominance of taxexternality in a sample of Swedish jurisdictions that can tax only personal income. We find avertical externality to be relatively dominant.QC 20140616