What drives vertical fiscal interactions? Evidence from the 1980 Crude Oil Windfall Act

Working paper

In economies with multi-level governments, why would a change in the scal rule of a gov-ernment in one level lead to a scal response by a government in a di¤erent level? Previous explanations focus on the standard common-pool problem. In this paper we study a new potential channel: complementarities between the public goods supplied by the two governments. First, we illustrate its potential key role in determining the sign of the vertical reaction through a standard model of horizontal tax competition with vertical scal interactions. Second, we propose a novel strategy for identifying it, by considering an empirical design that con nes the common-pool channel to speci c locations. We implement this design through a quasi-natural experiment: the 1980 U.S. Crude Oil Windfall Act, which increased federal tax collections from sale of crude oil, thereby a¤ecting the tax base of oil rich states speci cally. This latter feature enables attributing the vertical scal reactions of the remaining states to the complementarity channel. Following this strategy, via a di¤erence-in-di¤erences approach, we decompose the sources of the vertical scal reactions arising from this federal tax change and nd that those attributed to the novel channel: (i) point at complementarity between state and federal public goods; (ii) account for approximately 40% of the overall vertical scal response; (iii) are manifested primarily via corporate taxation.

Authors: Perez-Sebastian, F; Raveh, O

• Publication status: Published
• Publisher: University of Oxford
• Series: OxCarre Papers
• Publication date: 2016-11-23
• Paper number: 183
• Keywords: natural resources; federalism; common-pool problem; vertical fiscal reactions; complimentarities