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Tax Competition In A Simple Model With Heterogeneous Firms: How Larger Markets Reduce Profit Taxes

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  • Andreas Haufler
  • Frank Stähler

Abstract

We set up a simple two-country model of tax competition where firms with different productivity decide in which location to produce and sell output. In this model a unique, asymmetric Nash equilibrium can be shown to exist, provided that countries are sufficiently different with respect to their exogenous market conditions. Sorting of firms occurs in equilibrium, as the smaller country levies the lower tax rate and attracts the low-cost ¯rms. A simultaneous expansion of both markets that raises the profitability of firms intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases. This finding corresponds to the empirical evidence for the OECD countries over the last two decades.

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Bibliographic Info

Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 54 (2013)
Issue (Month): 2 (05)
Pages: 665-692

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Handle: RePEc:wly:iecrev:v:54:y:2013:i:2:p:665-692

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References

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Citations

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Cited by:
  1. Johannes Becker & Clemens Fuest, 2011. "Optimal tax policy when firms are internationally mobile," International Tax and Public Finance, Springer, vol. 18(5), pages 580-604, October.
  2. Langenmayr, Dominika & Haufler, Andreas & Bauer, Christian J., 2012. "Should tax policy favor high- or low-productivity firms?," Discussion Papers in Economics 14277, University of Munich, Department of Economics.
  3. Johannes Becker & Marco Runkel, 2010. "Even Small Trade Costs Restore Efficiency in Tax Competition," FEMM Working Papers 100023, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
  4. Krautheim, Sebastian & Schmidt-Eisenlohr, Tim, 2011. "Heterogeneous firms, ‘profit shifting’ FDI and international tax competition," Journal of Public Economics, Elsevier, vol. 95(1), pages 122-133.
  5. Johannes Becker & Clemens Fuest & Nadine Riedel, 2010. "Corporate tax effects on the quality and quantity of FDI," Working Papers 1013, Oxford University Centre for Business Taxation.
  6. Sebastian Krautheim & Tim Schmidt-Eisenlohr, 2012. "Wages and International Tax Competition," CESifo Working Paper Series 3867, CESifo Group Munich.
  7. Richard E. Baldwin & Toshihiro Okubo, 2009. "Tax Competition with Heterogeneous Firms," Discussion Paper Series 237, Research Institute for Economics & Business Administration, Kobe University.

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