Using Taxes to Attract the Creative Class in the Presence of a Region-Specific Rent

Abstract

We analyze interregional competition between two regions _A_ and _B_ that use taxes to attract a representative creative class member (the entrepreneur). This entrepreneur establishes a firm in either region _A_ or _B_ and this action guarantees her profit. However, if the entrepreneur locates in region _A_ then she also obtains a stochastic, location-specific rent that is either high with positive probability or low with positive complementary probability. In this setting, we accomplish three tasks. First, given values of the two tax rates, we determine the payoff to the entrepreneur in the two regions for the two possible values of the location-specific rent in _A_. Second, we ascertain when the entrepreneur will locate in _A_ for both values of the rent and when she will locate in _B_. Finally, we compute the tax rate that _B_ will set and then specify a condition which ensures that the entrepreneur locates in _B_.