This Paper considers tax competition and tax harmonization in the presence of agglomeration forces and falling trade costs. With agglomerative forces operating, industry is not indifferent to location in equilibrium, so perfectly mobile capital becomes a quasi-fixed factor. This suggests that the tax game is something subtler than a race to the bottom. Advanced 'core' nations may act like limit-pricing monopolists toward less advanced 'periphery' countries. Consequently, integration need not lead to falling tax rates, and might well be consistent with the maintenance of large welfare states. ‘Limit taxing’ also means that simple tax harmonization – adoption of a common tax rate – always harms at least one nation and adoption of a rate between the two unharmonized rates harms both nations. A tax floor set at the lowest equilibrium tax rate leads to a weak Pareto improvement.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
2630.
Find related papers by JEL classification: F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies F20 - International Economics - - International Factor Movements and International Business - - - General H00 - Public Economics - - General - - - General H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
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