IV. TAX-BASE CONFORMITY AND STATE TAX COMPETITION
The impact of tax-base conformity on state tax competition warrants separate analysis. From the perspective of state tax competition, the most important effect of conformity is horizontal harmonization. When the states incorporate by reference the federal tax base, the states end up using the same tax base--or nearly the same tax base--as each other. As a result, it is easier for mobile residents to compare tax burdens across states than if each state used a completely different base. Perfect base harmonization would allow taxpayers to compare state tax burdens by simply comparing nominal rates across states. At the other extreme, if every state constructed its tax base from scratch, comparing nominal state tax rates would tell residents nothing about effective tax burdens. Instead, to understand effective tax burdens, taxpayers would have to invest in learning about and comparing state tax bases. Whether facilitating the comparison of state tax burdens is salutary depends on whether state tax competition is productive or destructive. (178)
Commentators have argued that tax competition promotes welfare by constraining self-interested politicians who, without regard to voter preferences, seek to maximize tax revenue and the size of the public sector. (179) Under this view, residents "tame Leviathan" by exiting--or threatening to exit--the jurisdiction or by politically punishing lawmakers for imposing higher taxes than those applicable in neighboring states. Proponents of the Leviathan view would regard tax-base conformity as salutary because, by making it easier for taxpayers to compare tax burdens across states, conformity facilitates tax competition, thereby disciplining state taxing and spending.
On the other hand, if, instead of disciplining government officials, state tax competition sparks a destructive race to the bottom in which states compete for residents by lowering tax burdens until states cannot adequately fund public goods, then tax-base conformity is undesirable precisely because it facilitates easy comparison of competing tax rates. Using theoretical models, economists have shown that tax competition between the states may result in inefficiently low tax rates and, consequently, public sectors that are too small. (180) Empirical evidence provides some support for this view. (181) By obscuring effective tax burdens and thereby dampening competition, nonconformity therefore could shore up state tax revenues.
Notice, however, that regardless of whether the dominant effect of state tax base competition is to "tame Leviathan" or "beggar thy neighbor," federal-state tax-base conformity does not prevent robust tax competition. First, as long as conformity is only partial, states can compete with respect to deviations from the federal tax base. Additionally, even if all states have identical tax bases, they can still compete by offering different tax rates and menus of public goods. As long as states can distinguish themselves from each other via tax rates and public benefits, state competition can occur. Of course, uniform state tax bases would enhance tax competition by making it easier for mobile residents to compare state tax burdens. Even in the absence of perfect base conformity, however, empirical evidence shows that taxpayers discern and respond to differences in overall tax burdens across states. (182) Because tax burden competition can take place in the absence or presence of federal-state tax-base conformity, knowing whether such competition is destructive or salutary does not provide a complete answer to the question of whether states should conform to the federal tax base.
Nevertheless, conformity generates certain advantages that do not depend on answering the larger question about whether state tax competition is net beneficial or destructive. First, conformity aids Tieboutian sorting at the state …