Working Paper: CEPR ID: DP6186
Authors: Yasuhiro Sato; Jacques-François Thisse
Abstract: This paper investigates the impacts of capital mobility and tax competition in a setting with imperfect matching between firms and workers. The small country attracts fewer firms than the large one but accommodates a share of the industry that exceeds its capital share - a reverse home market effect. This allows the small country to be more aggressive and to set a higher tax rate than the large one, thus implying that tax competition reduces international inequalities. However, the large country always attains a higher utility than does the small country. Our model thus encapsulates both the 'importance of being small' and the 'importance of being large'. Last, tax harmonization benefits to the small country but is detrimental to the large one.
Keywords: capital mobility; fiscal competition; local labour markets; reverse home market effect
JEL Codes: F21; H31; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital mobility (F20) | international allocation of capital (F21) |
| higher tax rate (H29) | capital allocation to small country (G15) |
| capital mobility (F20) | utility levels in large country (L97) |
| tax competition (H26) | higher utility in small country (D69) |
| tax competition (H26) | reduction in international inequalities (F63) |
| tax harmonization (H26) | detriment to large country (F52) |