Abstract:
This paper models tax competition for mobile firms that are differentiated by
the amount of labor needed to cover fixed costs. Because tax competition affects the
distribution of firms, it affects both relative equilibrium wages across countries and
equilibrium prices. These in turn influence the equilibrium number of firms. From the
social planner's perspective, optimal tax rates are harmonized, providing the optimal
number of firms, and set such that income is efficiently distributed between private and
public consumption. As is common in tax competition models, in the Nash equilibrium
tax rates are inefficiently low, yielding underprovision of public goods. Furthermore,
there exist a variety of situations in which equilibrium tax rates differ. As a result, too
many firms enter the market as governments compete to be the low-tax, high-wage
country. This illustrates a new distortion from tax competition and provides an additional
benefit from tax harmonization.
