Revenue sharing can be used to discourage low tax regions from competing for capital and firms with high tax regions. However, with heterogeneous regions, revenue sharing involves net transfers across regions and creates a moral-hazard problem - that is, regions may want to invest less in market...

The paper considers a model of a federation with two heterogeneous regions that try to attract the capital by competing in capital income taxes and public investment that enhance the productivity of capital. The regions' choices determine the allocation of capital across the regions and their...