Federalism and Vertical Tax Competition

Abstract The division of shared tax bases between national and sub-national governments is a perennial source of conflict in federal nations. This Article compares historical trajectories in the four oldest constitutional federations—Switzerland, the United States, Canada, and Australia—to identify the causes, mechanics, and implications of “vertical tax competition,” the competitive process in which governments at one level attempt to increase their revenue at the expense of governments at a higher or lower level. The Article’s animating observation is that vertical tax competition has a centralizing tendency: national governments are likely to outcompete sub-national governments for revenue over the long run. This competitive advantage has a number of attractive economic implications, but it creates an ongoing risk for subnational autonomy and, more generally, the “balance” within federalism. This Article identifies the causes of this national advantage; the conditions under which subnational governments can limit it; a variety of legal responses that can be used to prevent extreme outcomes; and the implications for the governance of federalism. It also shows how these competitive dynamics and legal responses can help explain surprising differences between federal nations, including the relative fiscal power of national and subnational governments.