Tax Competition and Strategic Delegation with Interregional Asymmetries in Capital Endowment and Income Inequality

Takahiro Watanabe

doi:10.4236/tel.2019.95092

Abstract

This study examines a two-country tax competition model, in which the capital endowment and income inequality are asymmetric in each country. Hwang and Cheo [1] and Peralta and van Ypersele [2] show that when countries differ in capital endowments, the country with the higher capital endowment sets a lower capital tax rate. However, their studies assume that all inhabitants are homogeneous. We extend the models of the two aforementioned studies and conduct an analysis taking into account the asymmetry in income inequality within countries. The tax rate is set by the policy maker elected by majority voting in each country’s election. We find that a higher tax rate may be set in the country with higher capital endowment under certain conditions. Further, if the income inequality is sufficiently large, the median voters in each country unambiguously delegate the right to decide the tax rate to residents who prefer a higher tax rate than their own, regardless of the capital endowments of the two countries.

Highlights

The analysis of tax competition is becoming increasingly important because of globalization
This study examines a two-country tax competition model, in which the capital endowment and income inequality are asymmetric in each country
We extend the models of the two aforementioned studies and conduct an analysis taking into account the asymmetry in income inequality within countries

Summary

Introduction

The analysis of tax competition is becoming increasingly important because of globalization. Nishimura and Terai [18] consider the asymmetry of capital endowment among countries, but not the asymmetry of income distribution2 Their results, as well as those of Hwang and Cheo [1] and Peralta and van Ypersele [2], show that a lower tax rate is set in the country with higher capital endowment. When there is asymmetry of income inequality, this effect differs between countries, so the result indicated by Hwang and Cheo [1], Peralta and van Ypersele [2], and Nishimura and Terai [18] that a low tax rate is set in the country with high capital endowment may change.

The Model

Equilibrium

Second Stage

First Stage

Analysis

Conclusions