The efficient allocation of local public factors in Tiebout's tradition

Abstract

Tiebout's ( Journal of Political Economy , 1956, 64, 416–424) hypothesis is applied to the locational choice of firms in economies with local public inputs. A system of three source-based tax instruments is studied which, in combination with an earmarking rule, sustains production efficient allocations by decentralized decision-making. The system includes a local tax on pure profits, a local tax on land rents and a local lump-sum subsidy on the settlement of firms. The analysis is motivated by the practice in various countries of taxing profits locally at rates which can hardly be justified by service rivalry in the provision of local public factors. Applications to international economics are straightforward.