Taxation, Public Expenditures and Agglomeration

Recently, issues of international taxation have also been analysed from a New Economic Geographyperspective. These discussions show that adding agglomerative forces can change the results considerably.In our paper, we introduce a public sector into a Footloose Capital model: Capital income is taxed accordingto the residence principle and any tax revenue is spent for providing a public commodity. Thus,public policy changes the sectoral split of total expenditures, which is central for determining internationalfactor rewards and thus for factor mobility.We modeled this factor mobility process - along the lines of a replicator dynamics - in discrete timeand studied its local and global properties. We showed that multiple equilibria are possible, involvingcyclical and chaotic attractors; and that the basins of attraction may exhibit a highly complex structure. Inthat environment, the long run outcome of the dynamics process may depended highly sensitive to initialconditions and/or parameters. Public policy trying to attract industrial capital to one country may triggera dynamic process actually leading to agglomeration in the other country.