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A Quantitative Analysis of Tax Competition v. Tax Coordination under Perfect Capital Mobility

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  • Enrique G. Mendoza

    (University of Maryland and NBER)

  • Linda L. Tesar

    (University of Michigan and NBER)

Abstract

Theory predicts that strategically-determined tax rates induce negative externalities across countries in relative prices, the wealth distribution and tax revenue. This paper studies the interaction of these externalities in a dynamic, general equilibrium environment and its effects on quantitative outcomes of tax competition in one-shot games over capital income taxes between two governments that set time-invariant taxes and issue debt. Strategic payoffs correspond to welfare gains net of the cost of transitional dynamics in a standard neoclassical two-country model with exogenous balanced growth. The model is calibrated to European data for the early 1980s starting from a benchmark with symmetric countries. When countries compete over capital taxes adjusting labor taxes to maintain fiscal solvency, the Nash equilibrium replicates calibrated taxes, suggesting that European taxes can be the outcome of Nash competition. When consumption taxes are adjusted to maintain fiscal solvency, competition triggers a “race to the bottom” in capital taxes but this outcome is welfare-improving relative to calibrated taxes. Sensitivity analysis shows that competition can produce a “race to the top” in capital taxes and that the United Kingdom can benefit from tax competition with Continental Europe. Surprisingly, the gains from coordination in all of these experiments are small.

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Bibliographic Info

Paper provided by Research Seminar in International Economics, University of Michigan in its series Working Papers with number 507.

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Length: 42 pages
Date of creation: 2003
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Handle: RePEc:mie:wpaper:507

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Postal: ANN ARBOR MICHIGAN 48109
Web page: http://www.fordschool.umich.edu/rsie/
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Citations

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Cited by:
  1. Huizinga, Harry & Nielsen, Søren Bo, 2008. "Must losing taxes on saving be harmful?," Journal of Public Economics, Elsevier, vol. 92(5-6), pages 1183-1192, June.
  2. Dimitris Papageorgiou, 2009. "Macroeconomic Implications of Alternative Tax Regimes: The Case of Greece," Working Papers 97, Bank of Greece.
  3. Günther Rehme, 2007. "Economic Growth and (Re-)Distributive Policies in a Non-cooperative World," Journal of Economics, Springer, vol. 91(1), pages 1-40, May.
  4. Desai, Mihir A. & Foley, C. Fritz & Hines, James Jr., 2006. "Do tax havens divert economic activity?," Economics Letters, Elsevier, vol. 90(2), pages 219-224, February.
  5. Coenen, Günter & McAdam, Peter & Straub, Roland, 2007. "Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model," Working Paper Series 0747, European Central Bank.
  6. Eva de Francisco, 2005. "Limited Participation, Income Distribution and Capital-Account Liberalization: Working Paper 2005-02," Working Papers 16302, Congressional Budget Office.
  7. Eduardo Haddad & Alexandre A. Porsse & Eduardo P. Ribeiro, 2006. "Modeling Interjurisdictional Tax Competition in a Federal System," ERSA conference papers ersa06p359, European Regional Science Association.
  8. Eva de Francisco, 2005. "Limited Participation, Income Distribution and Capital Account Liberalization," Computing in Economics and Finance 2005 454, Society for Computational Economics.
  9. Enrique G. Mendoza & Linda L. Tesar, 2003. "Winners and Losers of Tax Competition in the European Union," NBER Working Papers 10051, National Bureau of Economic Research, Inc.
  10. Souleymane COULIBALY, 2008. "Empirical Assessment of the Existence of Taxable Agglomeration Rents," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 08.01, Université de Lausanne, Faculté des HEC, DEEP.

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