Equilibrium and Stratification with Local Income Taxation when Households Differ in both Preferences and Incomes

Schmidheiny, Kurt (December 2002). Equilibrium and Stratification with Local Income Taxation when Households Differ in both Preferences and Incomes (Diskussionsschriften 02-16). Bern: Volkswirtschaftliches Institut

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This paper presents a model of an urban area with local income taxes used to finance a local public good. Households differ in both incomes and their taste for housing. The existence of an asymetric equilibrium is shown in a calibrated two-community model assuming single-peaked distributions for income and housing taste. The equilibrium features segregation of households by both incomes and tastes. The high-tax community shows lower housing prices and lower public good provision than the low-tax community. The model is able to explain the substantial differences in local income tax level and average income across communities as observed in, e.g., Switzerland. The numerical investigation suggests that taste heterogeneity reduces the distributional effects of local tax differences. The numerical investigation also suggests that the ability of the rich community to set low taxes is higher when this community is physically small. However, a tax haven need not be small.

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