Abstract
The internal market in Europe will greatly increase the international mobility of resources. How will this affect fiscal policy in different countries? We consider taxation of capital in a two-country model, where a democratically-chosen government in each country chooses tax policy. Higher capital mobility changes the politico-economic equilibrium in two ways. On the one hand, it leads to more tax competition between the countries: this economic effect tends to lower tax rates in both countries. On the other hand, it alters voters' preferences and makes them elect a different government: this political effect offsets the increased tax competition, although not completely.
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