In this paper, we look at the issue of vertical tax competition – tax competition between different levels of government that share the same base. We compare Canada and the United States in terms of vertical tax competition. For the U.S analysis, we estimate separate models of vertical tax competition between the federal government and the states, and between states and their largest cities.  Taking account of the deductibility-related endogeneity of federal tax burdens by state, we find that federal income tax burdens have no effect on average state income tax burdens. However, introducing distributional considerations into the vertical tax competition model, we do find a significant displacement effect for higher income taxpayers, with higher federal burdens associated with lower state income tax burdens in the highest income quintile. For low-income taxpayers, federal and state tax burdens are found to be complementary.

For states and big cities, we find a tradeoff between state and local sales tax rates, implying an implicit exchange of tax burdens between a state and its cities.  A percentage point increase in the state sales tax rate decreases local collections by $90 per capita. Stated in the other direction, a $1 increase in local sales tax revenues is associated with a $1.63 decrease in state sales tax revenues.