Federalism, Taxation, and Economic Growth

We show that federalism will lead to higher economic growth. We present a model of endogenous growth where government services, funded by income and capital taxes, are a component of production. In this model a decentralized government will choose tax policy to maximize economic growth, while a centralized government will not do so. Furthermore, these conclusions hold regardless of whether the government is beholden to a median voter or is a rent-maximizing Leviathan. However, a decentralized government will under- provide a consumptive public good. Finally, we show our results are robust to imperfect capital mobility between districts and in such a model that districts with a lower total factor productivity will choose a more growth-enhancing tax policy.