Federal Income Tax and Its Effects On Inter- and Intracity Resource Allocation

Abstract

This article discusses the distortive effect of the federal income tax on the efficiency of resource allocation within and between cities. This distortion shifts production to the smaller and less productive cities from the larger and more productive cities. To eliminate these distortive effects, a city-size deduction should be applied. The underlying assumption is that cities differ from one another in labor productivity Consequently, in equilibrium, the size, the nominal income, and the price of housing vary across cities. When a uniform income tax rate is used for financing federal expenditure, the shadow price of housing exceeds the market price in the larger cities, indicating that the stock of housing is too small and the per-capita housing consumption is too large. The opposite is true in small cities, where also, if housing and the LPG (local public good) are net substitutes, the provision of the LPG is excessive. The article also discusses the effects of federal corporate profit taxes, which are shown to discourage the supply of the LPG, and shows that a net land rent tax is not always a feasible tax instrument capable of raising the predetermined tax revenue.