Working Paper: CEPR ID: DP501
Authors: Torsten Persson; Guido Tabellini
Abstract: The internal market in Europe will greatly increase the international mobility of resources. How will this affect fiscal policy in different countries? We first 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 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. We then consider taxation of labour, in a model where labour is internationally immobile. Eliminating the remaining barriers to trade in goods changes the distribution of labour earnings in the model, which again has a political as well as an economic effect. Again the economic and political effects push the tax rates in different directions, but here the political effect can prevail. The tendency for an adapting political equilibrium to preserve the status quo emerges as a general result of the paper.
Keywords: European integration; Politics; Tax competition
JEL Codes: H20; H30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher capital mobility (F20) | increased tax competition (H29) |
| increased tax competition (H29) | lower tax rates (H29) |
| higher capital mobility (F20) | lower capital taxation (F38) |
| political effects (F69) | offset economic effect (F69) |
| changes in labor taxation due to trade liberalization (F16) | significant adjustments in government policy (E65) |
| economic shifts (F69) | changes in identity of median voter (D72) |