Capital Tax Competition in the Presence of Rent-Shifting Incentives

Abstract

The tax competition literature usually specifies competitive product markets, so that the rent-shifting effect is overlooked. By incorporating an duopolistic product market, this paper considers two exporting countries that use capital taxes as devices to promote exports in a two-stage game. We find that when firms compete in terms of quantity, the rent-shifting effect aggravates the under-provision of public goods. However, when firms compete in terms of price, the rent-shifting effect reduces the inefficiency arising from tax competition. Moreover, we show that cooperation between exporting countries enhances the welfare of both countries in a Cournot duopoly, but this is not necessarily true in a Bertrand duopoly.