John William Hatfield (Stanford University, Graduate School of Business) has posted Revenue Decentralization, the Local Income Tax Deduction, and the Provision of Public Goods. Here is the abstract:

We consider a model where local and national governments invest in both productive and consumptive public goods using income tax revenue. Local governments will overprovide the consumptive public good if the local income tax is (partially) deductible. However, without full deductibility, local govern- ments will underprovide local productive public goods. Hence, to reduce the distortions in the local governments’ decisions, a welfare-maximizing national government will underinvest in both types of public goods. We also consider an alternative fiscal structure where the national government sets one national tax rate and provides transfers to the local governments: This results in lower welfare than one where local governments raise revenue independently.