Aspects of Interjurisdictional Sharing of the Value-Added Tax

Abstract

The sharing of consumption taxes between different levels of government has come to the fore in a number of developing countries in recent years with respect to the VAT. Employing a simple model that abstracts from considerations of equalization transfers and complications of tax competition, this article inquires about the determinants of an optimal arrangement for interjurisdictional sharing of the VAT base and revenue, and derives explicit solutions for the optimal central and local VAT rates, as well as the optimal revenue-sharing ratio between central and local governments on a derivation basis. The central finding is that an optimal VAT sharing arrangement is generally characterized by the simultaneous sharing of the VAT base and of the VAT revenue. The nature of the optimal solutions is shown to depend on the interactions among interjurisdictional differences in population, income, and the level of local government expenditure relative to local tax base.