Economic competition among jurisdictions: efficiency enhancing or distortion inducing?

Abstract

This paper explores the normative implications of competition among ‘local’ jurisdictions to attract new industry and income. Within a neoclassical framework, we examine how local officials set two policy variables, a tax (or subsidy) rate on mobile capital and a standard for local environmental quality, to induce more capital to enter the jurisdiction in order to raise wages. The analysis suggests that, for jurisdictions homogeneous in workers, local choices under simple-majority rule will be socially optimal; such jurisdictions select a zero tax rate on capital and set a standard for local environmental quality such that marginal willingness-to-pay equals the marginal social costs of a cleaner environment. However, in cases where jurisdictions are not homogeneous or where, for various reasons, they set a positive tax rate on capital, distortions arise not only in local fiscal decisions, but also in local environmental choices.