Daniel Hemel (New York) presents Separation of Bases and the Fiscal Constitution at Toronto, as part of its James Hausman Tax Law and Policy Workshop Series hosted by Ben Alarie:

A central concern of constitutional law and theory is the question of tax assignment: In a multilevel system of government, who gets to tax what? One conventional answer invokes the “separation of bases,” according to which constitutions should assign each tax base exclusively to one level of government. Proponents justify separation on two grounds: It prevents excessive taxation (the efficiency rationale), and it protects states from federal encroachment (the federalism rationale). These arguments have a centuries-long lineage in Anglo-American political economy and continue to feature prominently in constitutional litigation today.

This Article proposes a new account of tax assignment, one that reveals the conventional wisdom to be not only incomplete but, in key respects, backward. With regard to efficiency, we show that separating bases often forgoes significant synergies that arise when enforcement by one level of government facilitates tax collection by the other. With respect to federalism, we demonstrate through a game-theoretic model that constraints on Congress’s tax powers can confer a strategic advantage on the federal government in bargaining with the states—the opposite of the standard view, which posits that limits on federal tax authority redound to the states’ benefit.

These insights yield a new normative prescription for allocating tax authority in federal systems, which we call the “relative externalities principle.” According to that standard, separation of bases is optimal only when the negative externality from two governments overgrazing the same base exceeds the positive externality from both governments bolstering each other’s enforcement efforts. Our analysis also casts fresh light on the Direct Tax Clauses of the U.S. Constitution, which potentially curb Congress’s ability to tax property but—counterintuitively—strengthen the federal government’s hand in intergovernmental bargaining. Beyond the federal Constitution, our framework offers insight into the design of state constitutions, the ongoing debate over the state and local tax deduction, and the architecture of international tax cooperation.