NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Vertical Externalities in Tax Setting: Evidence from Gasoline and Cigarettes

Timothy J. Besley, Harvey S. Rosen

NBER Working Paper No. 6517 (Also Reprint No. r2211)*
Issued in March 1999
NBER Program(s):   PE

A common feature of federal systems is that tax bases are joint property. Consequently, state and federal tax setting decisions are interdependent. Our aim here is to put forward a rudimentary theoretical analysis of this phenomenon, and to use the theory as a framework for econometrically estimating the magnitude of the responses. We find that when the federal government increases taxes, there is a significant positive response of state taxes. For example, a 10-cent per gallon increase in the federal tax rate on gasoline leads to a 3.2-cent increase in the state tax rate.

*Published: Journal of Public Economics 70 (1998) 383-398

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