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Globalization, Tax Distortions, and Public-Sector Retrenchment

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  • Torben M. Andersen
  • Allan Sørensen

Abstract

It is widely perceived that globalization is a threat to tax financed public sector activities. The argument is that public activities (public consumption and transfers) financed by income taxes distort labour markets and cause higher wages and thus a loss of competitiveness. Since this link is strengthened by globalization, it is inferred that the marginal costs of public funds increase and a retrenchment of the public sector follows. We challenge whether these conclusions have support in a general equilibrium model featuring standard effects from open macroeconomics and trade theory. Even though income taxation unambiguously worsens wage competitiveness, it does not follow that marginal costs of public funds increase with product market integration due to gains from trade. Moreover, non-cooperative fiscal policies do not have a race-to-the-bottom bias despite that taxes harm competitiveness. In fact we identify an expansionary bias in ?scal policies that is likely to increase with globalization when taxes finance either public consumption or transfers.
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Suggested Citation

  • Torben M. Andersen & Allan Sørensen, 2012. "Globalization, Tax Distortions, and Public-Sector Retrenchment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 114(2), pages 409-439, June.
  • Handle: RePEc:bla:scandj:v:114:y:2012:i:2:p:409-439
    DOI: j.1467-9442.2011.01689.x
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    Citations

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    Cited by:

    1. Torben M. Andersen & Allan Sørensen, 2013. "Product market integration, tax distortions and public sector size," Economics Working Papers 2013-28, Department of Economics and Business Economics, Aarhus University.
    2. Jonathan Pycroft & Salvador Barrios, 2012. "Effective Green Taxation: Method and application to firm-level data," EcoMod2012 3874, EcoMod.
    3. Salvador Barrios & Jonathan Pycroft & Bert Saveyn, 2013. "The marginal cost of public funds in the EU: the case of labour versus green taxes," Taxation Papers 35, Directorate General Taxation and Customs Union, European Commission.

    More about this item

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • F1 - International Economics - - Trade
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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