Do we want to curtail internal tax competition?

I mentioned only a couple of days ago that tax credits for economic development do not work. Yet, politicians cannot help it to grant such credits, in part because they want to show they are doing something to help the economy, and in part because they genuinely think it works. And obviously, they do not take into account that other politicians do the same thing, and thus a competition emerges that gives away more and more tax credits for no local gain and certainly no aggregate gain. How could this vicious circle be broken?

Timothy Hubbard and Justin Svec have a proposal. The idea is that these tax credits create a negative externality on other jurisdictions. Thus one could apply the same strategy as for pollution, where a limited number of pollution permits are sold or distributed (the former being the preferred way). Here politicians would have tax credit permits, which they could trade as well. The Federal government would provide these permits and could even determine a socially efficient number of them. Next: name-calling permits for bloggers.