Abstract
In a common market with costless mobility of all factors regional governments can attract mobile firms by granting subsidies which they must finance out of wage taxes on mobile labour. Firms locate where subsidies are highest and workers settle where taxes are lowest, forcing government ‘in the splits’ (double Bertrand-type tax competition). Initially, there is unemployment in the economy. Regional governments then behave like middlemen in the labour market, and the fiscal game takes the form of competition among strategic intermediaries. Results from the theory of intermediation are applied to this framework. It is shown that government size may increase rather than decline in a fiscal competition, that industrial clustering may emerge from tax competition, and that tax competition may alleviate the unemployment problem.
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