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Tax Competition In A Simple Model With Heterogeneous Firms: How Larger Markets Reduce Profit Taxes

  • Andreas Haufler
  • Frank Stähler

We set up a simple two-country model of tax competition where firms with different productivity decide in which location to produce and sell output. In this model, a unique, asymmetric Nash equilibrium is shown to exist, provided that countries are sufficiently different with respect to their exogenous market size. Sorting of firms occurs in equilibrium, as the smaller country levies the lower tax rate and attracts the low-cost firms. A simultaneous expansion of both markets that raises the profitability of firms intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.

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File URL: http://hdl.handle.net/10.1111/iere.12010
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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 54 (2013)
Issue (Month): 2 (05)
Pages: 665-692

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Handle: RePEc:wly:iecrev:v:54:y:2013:i:2:p:665-692
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