Working Paper: CEPR ID: DP9969
Authors: Richard Baldwin; Toshihiro Okubo
Abstract: This paper studies tax competition in an economic geography model that allows for agglomeration economies with trade costs and heterogeneous firms. We find that the Nash equilibrium involves the large country charging a higher tax than the small nation. Lower trade costs lead to an intensification of competition, a drop in Nash tax rates, and a narrowing of the gap. Since large, productive firms are naturally more sensitive to tax differences in our model, large firms are the crux of tax competition in our model. This also means that tax competition has consequences for the average productivity of the big and small nations' industry; by lowering tax rates, the small nation can attract high-productivity firms.
Keywords: Average Productivity; Firm Heterogeneity; Nash Equilibrium; Tax; Spatial Sorting; Tax Cooperation
JEL Codes: H32; P16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lower trade costs (F19) | Nash tax rates (H29) |
| Nash tax rates (H29) | tax gap between large and small nations (H87) |
| tax rates (H29) | average productivity of firms (D22) |
| tax competition (H26) | average productivity in the south (O49) |
| tax competition (H26) | average productivity in the north (O49) |
| size of the country (R12) | tax rate (H25) |
| firm size (L25) | tax responsiveness (H32) |