An estimable model of income redistribution in a federation: Musgrave Meets Oates

Abstract
We develop a theory of cross-border income shifting in response to personal taxation, and examine its implications for the revenue potential and excess burden of personal taxes at the subnational level. We estimate the elasticity of tax avoidance and of cross-border tax base shifting using data on top income shares for Canadian provinces, finding that interprovincial shifting accounts for about two-thirds of total tax avoidance. We then propose a model demonstrating that a properly-chosen federal tax rate can offset the horizontal fiscal externality, allowing decentralized subnational tax rates to replicate the national welfare optimum.