Inefficient commuting in a city with spillovers

A Masters Thesis, presented as part of the requirements for the award of a Research Masters Degree in Economics from NOVA – School of Business and Economics

This paper presents a model of a duo-centric linear city where agents choose in which jurisdiction they want to work. Jurisdictions are unequally productive and local governments use a head tax and, possibly, a sourcebased wage tax, to nance a local public good. Each agent derives utility from both the local public good of the jurisdiction where he works and where he lives; thus, interjurisdictional commuting generates endogenous spillovers. We analyze the tax competition equilibrium when local governments use both the head and the wage tax and compare it to the utilitarian benchmark. We show that local public goods are underprovided in the most productive jurisdiction, and overprovided in the least productive one. We also show that distortive source-based wage taxation may improve upon the equilibrium with residence taxes alone, as it allows to charge commuters with part of the cost of the public good they enjoy.