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The Politics of 1992: Fiscal Policy and European Integration

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  • Persson, Torsten
  • Tabellini, Guido

Abstract

The internal market in Europe will greatly increase the international mobility of resources. How will this affect fiscal policy in different countries? We first consider taxation of capital in a two-country model, where a democratically-chosen government in each country chooses tax policy. Higher capital mobility changes the politico-economic equilibrium in two ways. On one hand, it leads to more tax competition between the countries: this `economic effect' tends to lower tax rates in both countries. On the other hand, it alters voters' preferences and makes them elect a different government: this `political effect' offsets the increased tax competition, although not completely. We then consider taxation of labour, in a model where labour is internationally immobile. Eliminating the remaining barriers to trade in goods changes the distribution of labour earnings in the model, which again has a political as well as an economic effect. Again the economic and political effects push the tax rates in different directions, but here the political effect can prevail. The tendency for an adapting political equilibrium to preserve the status quo emerges as a general result of the paper.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 501.

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Date of creation: Jan 1991
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Handle: RePEc:cpr:ceprdp:501

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Keywords: European Integration; Politics; Tax Competition;

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  1. Roger H. Gordon, 1982. "An Optimal Taxation Approach to Fiscal Federalism," NBER Working Papers 1004, National Bureau of Economic Research, Inc.
  2. Meltzer, Allan H & Richard, Scott F, 1981. "A Rational Theory of the Size of Government," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 914-27, October.
  3. Persson, Torsten & Tabellini, Guido, 1994. "Representative democracy and capital taxation," Journal of Public Economics, Elsevier, vol. 55(1), pages 53-70, September.
  4. Alberto Giovannini & James R. Hines, Jr., 1990. "Capital Flight and Tax Competition: Are There Viable Solutions to Both Problems?," NBER Working Papers 3333, National Bureau of Economic Research, Inc.
  5. Wildasin, D.E., 1987. "Nash equilibria in models of fiscal competition," CORE Discussion Papers 1987020, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  6. Vickers, John, 1985. "Delegation and the Theory of the Firm," Economic Journal, Royal Economic Society, vol. 95(380a), pages 138-47, Supplemen.
  7. Grandmont, Jean-Michel, 1978. "Intermediate Preferences and the Majority Rule," Econometrica, Econometric Society, vol. 46(2), pages 317-30, March.
  8. Peter A. Diamond, 1982. "Protection, Trade Adjustment Assistance, and Income Distribution," NBER Chapters, in: Import Competition and Response, pages 123-150 National Bureau of Economic Research, Inc.
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