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Oxford Economic Papers 2003; 55:104-120
Copyright © 2003 Oxford Universty Press

Article

Optimal taxation and risk-sharing arrangements in an economic federation

Thomas Aronsson and Magnus Wikström

Department of Economics, Umeå University, SE901 87 Umeå, Sweden; Thomas.Aronsson{at}econ.umu.se
Umeå University; magnus.wikstrom{at}econ.umu.se

Abstract

This paper analyzes optimal taxation and risk-sharing arrangements in an economy with two levels of government. Both levels provide public goods and finance their expenditures via labor income taxation, where the tax base is responsive to the private agents' labor supply decisions. The localities are assumed to experience different random productivity shocks, meaning that the private labor supply decision as well as the choices of income tax rates are carried out under uncertainty. Part of the central government's decision problem is then to provide tax revenue sharing between the local governments. The optimal degree of revenue sharing depends on whether or not the localities/regions differ with respect to labor supply incentives.


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