Fiscal competition: decentralization by José Roberto Afonso, Sérgio Guimarães Ferreira and Ricardo Varsano by 30 Years of the Brazilian Federal Constitution perspectives for Brazilian federalismo by Constantino Cronemberger Mendes Diana Chebenova Ana Carolina Lorena (Editors) published by IPEA (2019).
“Federalism may be defined as a system in which a central government and several decentralized (to a certain degree, autonomous) units cooperate, to some extent, in order to achieve common goals. Fiscal competition occurs in a situation where each federated unit decides independently on a tax or expenditure policy. It does not prevent concomitant cooperation in other fiscal and non-fiscal policies.
This is a more general definition to fiscal competition because it encompasses not only countries that are formally organized as federal constitutions, but also those whose public services and taxation are decentralized, as well as sovereign units that constitute an economic union. Furthermore, it indicates that fiscal competition is an event related to one extreme of the chain of possible combinations, specifically the hypothesis in which autonomy is completely exerted and there is no perfect coordination between units.
Competition between jurisdictions may be passive, meaning that independent actions are not intended to influence the conditions faced by the unit or other jurisdictions; or active, in the sense that taxation or expenditure is deliberately applied as an instrument to achieve a certain goal. Fiscal competition may be horizontal, when it involves governments that are at the same level; and vertical, when higher and lower levels of government are competitors. In all cases, one cannot predict whether competition will increase welfare or be detrimental to it.
This is the main issue addressed by the traditional literature on fiscal competition, as in the cases of articles by Tiebout (1956) and Oates (1972). There is no simple answer to such a complex question. It depends on several aspects, such as: the goals of the competing governments; what they are competing for; how they compete; the behavior of economic agents, especially their mobility in response to fiscal stimuli; and the characteristics of the economic environment, in particular the possibility of interjurisdictional externalities stemming from governmental actions.
Drawing from the old and immense literature on fiscal competition, this articles seeks to establish the basis for tracing typologies and some assessments and results that might help organize a debate on the subject. Therefore, the next section deals with the objects and instruments of fiscal competition. Section 3 gathers some empirical evidence of the existence of fiscal competition and the response of economic agents to interjurisdictional differences in taxes and benefits that come from public expenditures. Section 4 focuses on the main tools that may be used to avoid or neutralize possible harmful effects of fiscal competition. Section 5 summarizes the arguments presented in this paper…”
