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Tax Competition and Trade Protection

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  • Eckhard Janeba
  • John D. Wilson

Abstract

This paper reconsiders the question of whether tax competition for mobile capital leads to tax rates on capital that are too low or too high from the combined viewpoint of the competing regions (or countries in an economic union). In contrast to standard models of tax competition, both commodity trade and capital mobility is allowed to occur between the competing regions and the rest of the world. A key result of the analysis is that whether the capital taxes are too low or high depends on the degree of external trade protection. When the country's central government is free to set the tariff, tax competition leads to inefficiently low tax rates. But in the absence of a tariff, tax rates can be too high. In particular, regions may choose to subsidize capital in equilibrium as a means of inducing favorable terms-of-trade effects, but the subsidy (i.e., a negative tax) will then be too low because an increase in a single region's subsidy benefits other regions by reducing their relative quantities of subsidized capital. These results are discussed in the context of the European Union's Single Market, where non-EU firms have responded to the 'Fortress of Europe' by increasing foreign direct investment.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7402.

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Date of creation: Oct 1999
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Publication status: published as Janeba, Eckhard and Wolfgang Peters, "Tax Evasion, Tax Competition and the Gains from Nondiscrimination: The Case of Interest Taxation in Europe," The Economic Journal, Vol. 109, no. 452 (January 1999): 93-101
Handle: RePEc:nbr:nberwo:7402

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  1. Grossman, G.M. & Helpman, E., 1992. "Protection for Sale," Papers 162, Princeton, Woodrow Wilson School - Public and International Affairs.
  2. Clemens Fuest & Bernd Huber, 1999. "Can Tax Coordination Work?," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 56(3/4), pages 443-, July.
  3. Robert C. Feenstra, 1992. "How Costly Is Protectionism?," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 159-178, Summer.
  4. Brecher, Richard A. & Feenstra, Robert C., 1983. "International trade and capital mobility between diversified economies," Journal of International Economics, Elsevier, vol. 14(3-4), pages 321-339, May.
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Cited by:
  1. Libman, Alexander, 2005. "Взаимодействие Государственных И Частных Структур В Интеграционных Группировах: Теоретические Подходы И Оп," MPRA Paper 17044, University Library of Munich, Germany.
  2. Lenka Janíčková, 2012. "Tax Harmonization – the Possible Way out of the Crisis?," Český finanční a účetní časopis, University of Economics, Prague, vol. 2012(1), pages 64-81.
  3. Agnès Bénassy-Quéré & Lionel Fontagné & Amina Lahrèche-Revil, 2000. "Foreign Direct Investment and the Prospects for Tax Co-Ordination in Europe," Working Papers 2000-06, CEPII research center.
  4. Gaëtan Nicodème, 2006. "Corporate tax competition and coordination in the European Union: What do we know? Where do we stand?," European Economy - Economic Papers 250, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.

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