Model Of Tax Competition Research Articles

Why Finance Ministers Favor Carbon Taxes, Even If They Do Not Take Climate Change into Account

Fiscal considerations may shift governmental priorities away from environmental concerns: Finance ministers face strong demand for public expenditures such as infrastructure investments but they are constrained by international tax competition. We develop a multi-region model of tax competition and resource extraction to assess the fiscal incentive of imposing a tax on carbon rather than on capital. We explicitly model international capital and resource markets, as well as intertemporal capital accumulation and resource extraction. While fossil resources give rise to scarcity rents, capital does not. With carbon taxes the rents can be captured and invested in infrastructure, which leads to higher welfare than under capital taxation. This result holds even without modeling environmental damages. It is robust under a variation of the behavioral assumptions of resource importers to coordinate their actions, and a resource exporter’s ability to counteract carbon policies. Further, no green paradox occurs – instead, the carbon tax constitutes a viable green policy, since it postpones extraction and reduces cumulative emissions.

Implementing Partial Tax Harmonization in an Asymmetric Tax Competition Game with Repeated Interaction

This paper investigates the conditions under which partial harmonization for capital taxation is sustained in a repeated interactions model of tax competition when there are three countries with heterogenous capital endowments. We show that regardless of the structure of the coalition (i.e. full or partial tax coordination), whether partial tax harmonization is sustainable or not crucially depends on the extent to which the capital endowment of the medium-sized country is similar to that of the large or small country. The most noteworthy finding is that the closer the capital endowment of the median country is to the average one, the less likely the tax harmonization including the median country is to prevail and the more likely the partial tax harmonization excluding the median country is to prevail. We also show that partial tax harmonization makes the member countries of the tax union better off and non-member countries worse off, which stands in shape contrast with previous studies such as Konrad and Schjelderup (1999) and Bucovetsky (2009).

Market Structure, the Functional Form of Demand and the Sensitivity of the Vertical Reaction Function

Tax incidence and tax competition have largely been studied separately. Models assessing the incidence of excise taxes do not consider strategic interaction and exclusively assess the pass-through of taxes to prices. These settings focus on imperfectly competitive markets where prices can react more (less) than proportionally to a variation in tax rates. On the other hand, tax competition models focus on the strategic interactions arising because of a shared tax base but assume producer prices to be constant. Hence, the pass-through of taxes is restricted to be fully on consumers. This paper extends Keen (1997) by relaxing this assumption and, thus, by allowing local governments to internalize the possibility that taxes are over-shifted (undershifted). Interestingly, market structure (that was absent in previous settings), turns out to be one of the determinants of the vertical reaction function in this model; particularly determining the sensitivity of local tax setters to a variation of higher-tier taxes.

Tax rates as strategic substitutes

This paper analytically derives conditions under which the slope of the tax-reaction function is negative in a classical tax competition model. If countries maximize welfare, a negative slope (reflecting strategic substitutability) occurs under relatively mild conditions. The strategic tax response is crucial for understanding tax competition games, as well as the welfare effects of partial tax unions (whereby a subset of countries coordinate their tax rates). Indeed, contrary to earlier findings that have assumed strategic complementarity in tax rates, we show that partial tax unions might reduce welfare under strategic substitutability.

A note on equilibrium leadership in tax competition models

This paper reexamines the work of Kempf and Rota-Graziosi (J. Pub. Econ. 94: 768-776, 2010), which shows that leadership by the small region is the risk dominant equilibrium under the endogenous timing game. They obtained this result in a model where the asymmetry among regions translates into different gradients of the demand for capital but identical vertical intercepts. In this paper, we simply reverse the form of asymmetry by considering different vertical intercepts but identical gradients. The reason is that market power is typically related to the intercept and not to the slope of the demand function. We then show that leadership by the large region becomes the risk dominant equilibrium and can even become Pareto superior.

Are Local Tax Rates Strategic Complements or Strategic Substitutes?

The identification of strategic interactions among local governments is typically plagued by endogeneity problems. I exploit the fact that local jurisdictions located close to a state border have some neighbors in another state and instrument the tax rate of neighbor jurisdictions with the state-level tax rate of the neighboring state. I use this instrument to identify strategic personal income tax setting by local jurisdictions in Switzerland and find that tax rates are strategic substitutes. I then develop a residence-based personal income tax competition model and show that tax rates are strategic substitutes if the elasticity of the marginal utility of the public good with respect to the tax rate is above one. This is notably the case in the presence of economies of scale in the public good provision. (JEL H24, H71, H73, H77)

Tax Rate Harmonization, Renegotiation, and Asymmetric Tax Competition for Profits with Repeated Interaction

AbstractThis paper analyzes a model of corporate tax competition with repeated interaction and with strategic use of profit shifting within multinationals. We show that international tax coordination is more likely to prevail if the degree of asymmetry in terms of productivity differences between countries is smaller, or if concealment costs of profit shifting are larger when the tax authorities adopt grim‐trigger strategies. Allowing for renegotiation in the tax harmonization process requires more patient tax authorities to implement tax harmonization as a weakly renegotiation‐proof equilibrium. In this case, we find somewhat paradoxical situations where higher costs of profit shifting make tax harmonization less sustainable.

The Influence of Altruistic Preferences on the Race to the Bottom of Welfare States

Common tax competition models suggest that welfare states will undercut each other's tax rate to attract taxpayers and keep welfare recipients at bay. This will lead to a zero-taxation outcome in the absence of migration costs or other barriers to migration. This paper develops a two-country framework with mobile altruistic taxpayers and immobile welfare recipients. It shows that under the assumption of taxpayers motivated by warm glow altruism, tax competition leads to unique pure strategy Nash equilibria in taxation which are different from zero given sufficiently strong altruistic preferences. If countries are asymmetric with respect to the number of welfare recipients, pure altruism and inequity aversion preferences support additional unique pure strategy Nash equilibria in which the country with the fewer poor attracts more taxpayers and sets higher taxes. This implies that rich countries may benefit from tax competition.

Tax Enforcement Policy and the Provision of Public Goods with the Presence of Tax Havens

AbstractA tax competition model is presented to investigate the effects of tax havens on the public good provision. We show that when countries facing a rise in tax havens change their tax enforcement strategies in response, the existence of tax havens may result in a higher level of equilibrium public good provision as compared to the case with no tax havens. Accordingly, tax havens could be welfare enhancing for non‐haven countries. This result offers a possible explanation for the recent empirical evidence that the corporate tax revenues in high‐tax countries have actually increased with the growth in the flow of foreign direct investment to tax havens.

Tax competition among European countries. Does the EU matter?

This paper provides a simple theoretical model of capital tax competition between countries that differ in spatial location, and where cross-border investment costs are proportional to distance (a gravity model). We model EU membership as a reduction in ‘distance’ between countries. Precise predictions about reaction functions' intercepts and slopes are derived. In particular we find that joining the Union lowers the intercept and that all countries react more to member countries than they do to non-members. These predictions are largely confirmed using a panel data set of statutory corporate tax rates on Western European countries.

Capital Tax Competition and Cooperation with Endogenous Capital Formation

AbstractIncorporating consumption–savings choices under a general concave utility function and hence an endogenous capital supply into a model of capital tax competition, we re‐investigate Nash equilibrium and compare it with the optimum under cooperative tax policy. In contrast to the case of fixed capital supply, it is shown that if savings sufficiently increase with the interest rate, a Nash equilibrium may be more efficient than a cooperative tax policy. Therefore, the distortionary effects of capital supply are important to issues of tax policy coordination.

Public Goods Provision, Redistribution and Capital Mobility

Two results follow from the standard workhorse model of tax competition. One is that tax competition between countries leads to underprovision of public consumption goods (see Zodrow and Mieszkowski 1986). The other that tax competition lowers capital taxes and may lead to less redistribution due to higher e¢ ciency costs of capital taxation. This paper embeds both public goods provision and redistribution in a single model framework, and shows that preferences for income redistribution may alter the standard result of under-provision of public goods under tax competition.

Taxes in Cities

Most cities enjoy some autonomy over how they tax their residents, and that autonomy is typically exercised by multiple municipal governments within a given city. In this chapter, we document patterns of city-level taxation across countries, and we review the literature on a number of salient features affecting local tax setting in an urban context. Urban local governments on average raise some ten percent of total tax revenue in OECD countries and around half that share in non-OECD countries. We show that most cities are highly fragmented: urban areas with more than 500,000 inhabitants are divided into 74 local jurisdictions on average. The vast majority of these cities are characterized by a central municipality that strongly dominates the remaining jurisdictions in terms of population. These empirical regularities imply that an analysis of urban taxation needs to take account of three particular features: interdependence among tax-setting authorities (horizontally and vertically), jurisdictional size asymmetries, and the potential for agglomeration economies. We survey the relevant theoretical and empirical literatures, focusing in particular on models of asymmetric tax competition, of taxation and income sorting and of taxation in the presence of agglomeration rents.

Fiscal Transfer in a Repeated-Interaction Model of Tax Competition

This paper analyzes how a fiscal transfer scheme affects tax cooperation in a repeated-interaction model of tax competition. In particular, the paper studies whether a fiscal transfer scheme promotes or blocks voluntary tax cooperation. It is shown that the larger the scale of fiscal transfer is, the easier voluntary tax cooperation is, implying that interregional transfers for correcting fiscal gaps are consistent with voluntary tax cooperation.

The Influence of Altruistic Preferences on the Race to the Bottom of Welfare States

Common tax competition models suggest that welfare states will undercut each other's tax rate to attract taxpayers and keep welfare recipients at bay. This will lead to a zero-taxation outcome in the absence of migration costs or other barriers to migration. This paper develops a two-country framework with mobile altruistic taxpayers and immobile welfare recipients. It shows that under the assumption of taxpayers motivated by warm glow altruism, tax competition leads to unique pure strategy Nash equilibria in taxation which are different from zero given sufficiently strong altruistic preferences. If countries are asymmetric with respect to the number of welfare recipients, pure altruism and inequity aversion preferences support additional unique pure strategy Nash equilibria in which the country with the fewer poor attracts more taxpayers and sets higher taxes. This implies that rich countries may benefit from tax competition.

Asymmetric competition in the setting of diesel excise taxes in EU countries

This paper tests new implications of the asymmetric tax competition model on diesel excise taxes. We extend the standard tax competition model by replacing the unit demand assumption with iso-elastic demand. As a result, not only the level of the equilibrium tax, but also the slope of the tax reaction function depends positively on the size of the country. The new implication is tested on panel data in first differences for 16 countries of Western Europe. The results provide strong evidence for strategic interaction in the setting of diesel excises and confirm the effect of country size on the response to tax changes in neighbouring countries. Strategic interaction between EU countries intensified in the mid-1990s and drove small European countries to set lower diesel tax rates. These results explain why the EU’s minimum tax policy has failed to harmonise diesel tax rates.

Bigger Countries with Probably Lower Commodity Taxes

The article studies a spatial model of commodity tax competition between two countries that may differ in both population density and land mass, synthesizing two earlier contributions where pure strategy equilibria always existed and where the ‘bigger’ country (that with the larger population) set the higher tax. In our more general setting, pure strategy equilibria may not exist, but we can compute a mixed strategy equilibrium, which offers probabilistic alternatives to the empirically questionable ‘big country-high tax’ correlation; the bigger country may have a lower ‘expected’ tax rate and may be ‘more likely’ to be the low tax country.

Capital allocation in an asymmetric tax competition model with agglomeration economies

In this study, we analyze asymmetric tax competition in the presence of capital agglomeration effects. As is well known from traditional studies of asymmetric tax competition, a pecuniary externality arises and distorts the efficiency of capital allocation between regions. We show that the difference-in-capital-endowment can improve the efficiency of capital allocation in the economy.

Dutch Disease, factor mobility, and the Alberta Effect: the case of federations

AbstractDo reduced costs of factor mobility mitigate Dutch Disease effects to the extent that they are reversed? The case of federations provides an indication they do. We observe resource blessing (curse) effects at the provincial (federal) level, and argue the difference in outcomes stems from the difference in factor mobility costs. We construct a simple tax competition model which shows that if factor mobility costs are sufficiently low, a resource‐boom triggers an Alberta Effect that mitigates, and possibly reverses, Dutch Disease symptoms. The paper concludes with empirical evidence for the main implications of the model.

An extension of the home-attachment criteria under dynamic tax competition

In this short note we extend the home attachment setting of Mansoorian and Myers (1993) and Ogura (2006) to allow the study of tax competition in a dynamic framework when international business relocation occurs over successive periods. The dynamic framework we propose also helps to understand why tax rates may change over time. Our modified home-attachment rule is illustrated by a simple model of dynamic tax competition in discrete time.