In theory, fiscal federalism is a great tool that holds state and local governments accountable for their policy actions. In practice, it hardly exists. The increasing scope of federal programs and grants has largely eroded its impact on policy decisions by state and local government to the point that tax considerations become almost irrelevant in people’s decisions about where to live.By removing the natural check that mobility imposes on bad state tax policy, those who favor expanding the scope of federal government activity make it difficult to correct bad state tax policy.
All other things being equal, it remains less costly to live or run a business in a low-tax rate state than in a high-tax rate one. However, when the central government imposes an ever-increasing percentage of each taxpayer’s total tax burden, differences in state taxes become less important. In other words, if your main tax burden is going to be the same wherever you live, why bother even moving to another state, especially if you get to deduct your state taxes from your federal ones? Being able to deduct state taxes from the federal burden obviates any differences between the states.So say goodbye to Tiebout.