Revenue Equalization Systems in a Federation with Tax Evasion

Abstract

We analyse how vertical or horizontal fiscal equalization affects the overprovision of local public goods due to vertical fiscal externality, when there is tax evasion. The regional governments overspending incentive is examined both in case of a fiscal equalization based on pretax earned income and reported taxable income.Fiscal federalism; Equalization; Marginal Cost of Public Funds, Tax evasion