Fiscal Equalization as a Coordination Device

Taxing capital in open economies su¤ers from a rather wasteful tax competition. According to Konrad & Schjelderup (1999) harmonizing capital income taxes within a subgroup of countries is bene…cial to all countries. Although economists and politicians advocate a coordinated tax policy within a federation or a federal system like the EU they favor national tax sovereignty over a harmonization of tax rates. This paper shows why a direct coordination on tax rates (harmonization) is dominated by implementing an indirect mechanism which redistributes tax revenues within a federation (…scal equalization). JEL classi…cation: C7, H2, H7 Keywords: Fiscal equalization, tax competition, tax coordination We are grateful to the participants of a public economics workshop at the Science Center Berlin (WZB) for stimulating comments. Furthermore, we want to thank the German Research Foundation (DFG) for …nancial support through the SPP 1142 program on ”Institutional Design of Federal Systems”.