Tax Competition:

When some taxes are assigned to the decentralized governments, may be states or local governments, in a federal economy, these governments often develop competition among themselves to increase their respective tax bases. They often compete to attract the residents, business, industry etc. whose economic activities increase the value of the tax bases of the respective jurisdictions. Such competition often leads to competitive reduction of tax rates, as it happened in the case of Sales Tax before the implementation of uniform floor rates by all the states since January, 2000, ultimately acting as a constraint on the size of their respective budgets. In other words, state or local tax jurisdictions hesitate to increase the tax rates for fear of loss of business and industry given the levels of public expenditure and public services. So the possibilities of locational effects of different tax bases are to be considered before assigning the taxes to lower levels of governments.