Heterogeneous Capital Tax Competition in a Federation with Tax Evasion, DISEI WP N. 19/2019

In a federal country with two regions, consumers can decide not only the region where to invest, but also the type of capital investment. We analyse how such decision is affected by two sources of asymmetry: a first type of capital is taxed at a regional level while a second one is taxed at a federal level, and for the latter a different degree of tax evasion may arise across regions. We show how tax evasion arising at a federal level affects not only the federal tax policy but also the regional tax policies both directly and indirectly because of vertical tax competition. In particular, we show under which conditions a decrease in the level of tax compliance on the second type of capital can lead to a reduction in its federal tax rate, and simultaneously to an increase in the regional tax rate on the other type of capital investment.