Tax Competition and Migration: the Race-to-the-Bottom Hypothesis Revisited

Abstract

Oates reminds us that tax competition among localities in the presence of capital mobility, may lead to inefficiently low tax rates (and benefits). In contrast, the Tiebout paradigm suggests that tax competition yields an efficient outcome, so that there are no gains from tax coordination. This article demonstrates that when a group of host countries faces an upward supply of migrants, labor and capital income tax rate under competition are higher than under tax coordination, due to a fiscal externality. In this article, we re-examine the race-to-the-bottom hypothesis when sev- eral host countries compete for an upward slopping supply of immigrants from the rest of the world. We also revisits the Tiebout paradigm, which suggests that the tax competition yields efficient outcomes. We assume that there is a large enough number of competing host coun- tries, to allow us to treat each host country as a 'perfect competitor'. The rest of the world serves as a reservoir of migrants for the host countries. That is, the rest of the world provides exogenously given, upward sloping, supply curves of unskilled and skilled immigrants to the host countries. We address the issue whether tax competition among host countries is inefficient, relative to tax coordination, in the presence of migration. Referring to tax competition among localities in the presence of capital mobility, Oates (1972, p. 143) argues that competition may lead to ineffi- ciently low tax rates (and benefits): The result of tax competition may well be a tendency toward less than efficient levels of output of local services. In an attempt to keep taxes low to attract business investment, local officials may hold spending below those levels for which marginal benefits equal marginal costs, particularly for those programs that do not offer direct benefits to local business. Considering international capital mobility, tax competition among countries may lead to inefficiently low tax rates and welfare-state benefits