Working Paper: NBER ID: w7402
Authors: Eckhard Janeba; John D. Wilson
Abstract: This paper reconsiders the question of whether tax competition for mobile capital leads to tax rates on capital that are too low or too high from the combined viewpoint of the competing regions (or countries in an economic union). In contrast to standard models of tax competition, both commodity trade and capital mobility is allowed to occur between the competing regions and the rest of the world. A key result of the analysis is that whether the capital taxes are too low or high depends on the degree of external trade protection. When the country's central government is free to set the tariff, tax competition leads to inefficiently low tax rates. But in the absence of a tariff, tax rates can be too high. In particular, regions may choose to subsidize capital in equilibrium as a means of inducing favorable terms-of-trade effects, but the subsidy (i.e., a negative tax) will then be too low because an increase in a single region's subsidy benefits other regions by reducing their relative quantities of subsidized capital. These results are discussed in the context of the European Union's Single Market, where non-EU firms have responded to the 'Fortress of Europe' by increasing foreign direct investment.
Keywords: No keywords provided
JEL Codes: F13; F21; H73
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| central government's ability to set tariffs (H10) | tax competition results in inefficiently low tax rates on capital (H21) |
| absence of tariffs (F19) | tax rates may be too high (H29) |
| regions choose to subsidize capital (R38) | favorable terms-of-trade effects (F16) |
| favorable terms-of-trade effects (F16) | subsidy is too low (H23) |
| subsidy is too low (H23) | benefits shared across regions (R10) |
| benefits shared across regions (R10) | reduces incentive for any single region to increase its subsidy (H23) |