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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

An important puzzle in corporate taxation is that effective tax rates have fallen significantly while tax revenue has simultaneously risen in most countries. Moreover, the gross profitability of firms seems to be lower in high-tax countries, even though standard models of international investment would yield the opposite conclusion. We offer an explanation for these stylized facts by setting up a simple two-country model of tax competition with heterogeneous firms. 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. In equilibrium the larger country levies the higher tax rate and attracts the high-cost firms. A simultaneous expansion of both markets intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2867.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2867

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Keywords: tax competition; heterogeneous firms; imperfect competition;

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References

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Citations

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Cited by:
  1. Johannes Becker & Clemens Fuest, 2009. "Optimal tax policy when firms are internationallly mobile," Working Papers 0907, Oxford University Centre for Business Taxation.
  2. Sebastian Krautheim & Tim Schmidt-Eisenlohr, 2011. "Wages and International Tax Competition," Working Papers 1123, Oxford University Centre for Business Taxation.
  3. 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.
  4. Dominika Langenmayr & Andreas Haufler & Christian Josef Bauer, 2012. "Should Tax Policy Favor High- or Low-Productivity Firms?," CESifo Working Paper Series 4034, CESifo Group Munich.
  5. Richard E. Baldwin & Toshihiro Okubo, 2014. "Tax Competition with Heterogeneous Firms," CAMA Working Papers 2014-36, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  6. Krautheim, Sebastian & Schmidt-Eisenlohr, Tim, 2011. "Heterogeneous firms, 'profit shifting' FDI and international tax competition," Journal of Public Economics, Elsevier, vol. 95(1-2), pages 122-133, February.
  7. Johannes Becker & Marco Runkel, 2010. "Even Small Trade Costs Restore Efficiency in Tax Competition," CESifo Working Paper Series 3221, CESifo Group Munich.

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