The (Im)Possibility of Overprovision of Public Goods in Interjurisdictional Tax Competition

We extend the classical tax-competition framework of Zodrow and Mieszkowski (1986) by modeling involuntary unemployment and by allowing for labor taxation as a second source of public funds. Even though the framework of the Zodrow-Mieszkowski model is extended into two dimensions, we are able to characterize the signs of both tax rates and the provision level of the public good: for a large class of production functions (including CES), tax competition is characterized by underprovision of public goods, and by positive taxes on both labor and capital. Since this holds true (with some qualifications) for various labor market models (including efficient bargains, the monopolistic union, and competitive labor markets), we can safely conclude that the results of Zodrow and Mieszkowski survive some important and substantial modifications of the framework, and are thus more general than recently suggested elsewhere.