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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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Cited by:
  1. Sebastian Krautheim & Tim Schmidt-Eisenlohr, 2009. "Heterogeneous Firms, "Profit Shifting" FDI and International Tax Competition," Documents de travail du Centre d'Economie de la Sorbonne 09073, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  2. Becker, Johannes & Runkel, Marco, 2012. "Even small trade costs restore efficiency in tax competition," Journal of Urban Economics, Elsevier, vol. 72(2), pages 191-195.
  3. 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.
  4. 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.
  5. Richard E. Baldwin & Toshihiro Okubo, 2009. "Tax Competition with Heterogeneous Firms," Discussion Paper Series 237, Research Institute for Economics & Business Administration, Kobe University.
  6. Johannes Becker & Clemens Fuest, 2009. "Optimal tax policy when firms are internationallly mobile," Working Papers 0907, Oxford University Centre for Business Taxation.
  7. Sebastian Krautheim & Tim Schmidt-Eisenlohr, 2012. "Wages and International Tax Competition," CESifo Working Paper Series 3867, CESifo Group Munich.

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