Transfer and tax competition in a system of hierarchical governments

This paper analyzes the relation between tax competition and interregional transfer in an economic geography framework. In the absence of a transfer scheme, we show that a purely decentralized tax system in an economy with asymmetric regions can lead to more agglomeration effects than those resulting from the free market location equilibrium. Moreover, the model suggests that a transfer mechanism with an explicit redistributive character leads to a lower local tax pressure. Finally, we show that a myopic behavior adopted by the region which contributes to the transfer gives rise to an involuntary decrease in the federal tax.