Working Paper, Department of Economics, Johannes Kepler University of Linz 0005
State and local taxation comprises those taxes that are collected at the sub-federal government levels in order to finance state and local public services, assigning discretion in the determination of rates and bases of these taxes to sub-federal governments. Consider a nation with different layers of government that are only serving administrative purposes. Each government level only distributes the public services to and collects the taxes from that nation’s citizens upon which they agreed at the national level. In such a country, no state or local taxation is necessary since the level of public goods and services is uniformly decided upon for the whole country. This leaves citizens in some local jurisdictions, which prefer more public services than the national average, as much dissatisfied as citizens in local jurisdictions, which prefer less. It is possible to provide public services, the benefits of which are geographically limited and which are not national in scope, at different levels in different sub-federal jurisdictions. Enabling citizens to consume publicly provided goods and services at different levels according to their preferences makes everyone better off without making someone worse off. In order to let people, who want to consume more, pay a higher tax price for those state and local services, taxes must be differentiated accordingly between states and local jurisdictions. In such a world with a differentiated supply of publicly provided goods, each individual can reside in a jurisdiction where a certain level of public services is provided to adequate tax prices. The art of state and local taxation is the assignment of different kinds of taxes to government levels such that an invisible hand properly guides a nation in an ideal world to an optimal multi-unit fiscal system. This is not necessarily the case in the real world and some answers exist why fiscal systems are not optimal.