Cross-border shopping and commodity tax competition among governments

Abstract

The purpose of this paper is to analyze Nash tax competition among governments that differ in geographical aspects such as their sizes and positions. Each government lying on a linear market maximizes its revenue with respect to its own commodity tax rate, taking into account the cross-border shoppings induced by the difference in tax rates. In particular, we examine how the size of the countries and their spatial arrangement affect tax rates and government revenues at a Nash equilibrium. We show that a small country chooses a lower tax rate than a big country, and obtains more than its size-proportional share of total revenue at the Nash equilibrium. We also prove that when the size of all countries are identical, the tax rates levied by the governments go down from either market boundary toward the market center, and the adjoining countries of peripheral countries can obtain the largest government revenue.