How Fiscal Decentralization Flattens Progressive Taxes

We study the tension between fiscal decentralization and progressive taxation. We present a multi-community model in which households differ in incomes and housing preferences and in which the local income tax rate is a function of an exogenous progressive tax schedule and an endogenous local tax multiplier. The progression of the tax schedule induces a self-sorting process that results in substantial though imperfect income sorting. Considering this income sorting, the resulting tax schedule is less progressive than the exogenous tax schedule. Empirical evidence from the largest Swiss metropolitan area supports the predictions of our model.