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Over the past decades there has been in many countries a progressive movement towards the devolution of fiscal powers to sub-central governments, a process which is commonly known as fiscal devolution or fiscal decentralization.
This has generally been advised on grounds of improving government efficiency and accountability.
In particular, advocates of fiscal decentralization point tax competition as the main mechanism that promotes economic development.
The European Union (EU) provides, in this context, an ideal ground for looking at the effects of tax competition.
We show that tax competition brings growth-maximizing policies.
Yet, this translates into a 'race to bottom' on the taxation of mobile factors, together with a 'race to the top' on the taxation of immobile factors.
Hence, fiscal devolution limits the scope for redistribution and brings potentially large regional asymmetric effects.
Against this background, we examine several possible tax harmonization scenarios that may be considered in the EU context.
In a nutshell, capital tax harmonization is able to avoid a race to bottom in capital taxation but implies a race to the top in labour taxation.
Only labour income tax harmonization is able to avoid the latter, while leaving room for a positive capital tax.
