Fiscal Decentralization : Efficiency vs. Redistribution? An Institutional Feature to Resolve the Trade-Off

Fiscal decentralization leads to a more efficient allocation of public fund and restricts the government to exploit the tax base. However, standard theory also suggests strong negative distributional effects and thus, centralized redistribution is proposed. This trade-off between efficiency and distribution is well established. For the case of decentralized taxation we suggest that a simple institutional feature - the separation of the decision to set the rate of progression from the decision to set the 'level' of taxation - can mitigate this trade-off. Our analysis focuses on decentralized taxation in Switzerland, where this simple mechanism is at work for already a long time. We estimate the influence of varying degrees of decentralization on the general 'level' as well as the structure of decentralized income taxes. Our empirical results indicate that more decentralized jurisdictions feature generally lower income taxes and impose higher rates of progression