Fiscal competition and interindustry trade

Abstract

Neighboring economies — cities, states and provinces, countries — often are strongly linked through a large volume of interindustry trade. The tax and expenditure policies chosen by one jurisdiction will affect its neighbors through these channels. A model is developed of two jurisdictions, one of which is the upstream supplier of an intermediate input for the other's export industry. Theoretical analysis shows how changes in tax policy in either jurisdiction affect wages and welfare for the residents of both jurisdictions, highlighting the fiscal interactions arising from the interindustry trade linkages. With appropriate simplifying assumptions, predictions about the direction of these effects can be made. More generally, however, the sign and magnitude of these interactions depend on a number of empirical parameters characterizing technology and trade. Numerical calculations provide a first-order analysis of the impact of policy changes when specific values are assumed for these parameters.