Sorting, tax competition and the rise of local tax heavens
This paper develops an income tax competition model in which mobile households are heterogeneous in income.We address the following questions: (i) Which balancing forces provide competing local governments with incentives to host households with heterogeneous income in their jurisdictions; (ii) Does tax competition among local governments amplifies or dampens the income sorting effects of amenity chocs? We identify necessary conditions for the existence of a general equilibrium. Our simulations show that a positive amenity choc in a jurisdiction disproportionately attracts richer households. This spurs its local government to provide more public good and increase its tax rate, which further attracts richer households. Public good provision increases more than the tax rate.