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Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit taxes

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  • Haufler, Andreas
  • Stähler, Frank

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 heterogenous 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 University of Munich, Department of Economics in its series Discussion Papers in Economics with number 11120.

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Date of creation: 23 Nov 2009
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Handle: RePEc:lmu:muenec:11120

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Keywords: tax competition; heterogeneous firms; imperfect competition;

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References

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Cited by:
  1. Becker, Johannes & Fuest, Clemens & Riedel, Nadine, 2012. "Corporate tax effects on the quality and quantity of FDI," European Economic Review, Elsevier, vol. 56(8), pages 1495-1511.
  2. Sebastian Krautheim & Tim Schmidt-Eisenlohr, 2012. "Wages and International Tax Competition," CESifo Working Paper Series 3867, CESifo Group Munich.
  3. Johannes Becker & Clemens Fuest, 2005. "Optimal Tax Policy when Firms are Internationally Mobile," CESifo Working Paper Series 1592, CESifo Group Munich.
  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. 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.
  6. Johannes Becker & Marco Runkel, 2010. "Even Small Trade Costs Restore Efficiency in Tax Competition," CESifo Working Paper Series 3221, CESifo Group Munich.
  7. 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.

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