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Tax Harmonization versus Tax Competition in Europe: A Game Theoretical Approach

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The purpose of this paper is to use a game theoretical approach to analyze tax harmonization, or competition, in a monetary union, more specifically in Europe. Without harmonization, free-riding behaviors may appear, leading to a sub-optimal tax equilibrium. Tax competition may also create budgetary problems and the objective of a balanced budget may not be attained. But national tax autonomy has one main advantage: as monetary policy is 'federalized', and as fiscal policy is constrained by the Stability and Growth Pact, taxation becomes the last macroeconomic instrument within governments' hands to deal with asymmetric shocks. The literature often condemns tax autonomy because of possible free-riding behaviors. In such a case, the competition could conduct to the lowest tax rate of all countries, condemning others to diminish their public spending. But, this analysis rests on a static point of view: In that case, harmonization with strict rules is Pareto-optimum. In the dynamic case, as harmonization costs are not incurred, the final equilibrium may be of a higher welfare level. Coordination would occur without the need for strict rules. If countries maintain sound public finance, tax competition would not lead to a 'race to the bottom'. L'objet de ce papier est d'utiliser une approche en terme de théorie des jeux afin d'étudier les questions d'harmonisation ou de compétition fiscale au sein d'une union monétaire. Plus spécifiquement, cette étude concerne l'Union économique et monétaire et le risque de « guerre d'usure ». Les arguments traditionnels sont d'une part que sans harmonisation, des comportements de « free-riding » peuvent apparaître, menant à un équilibre sous optimal en matière de politique fiscale, et d'autre part que la compétition peut aussi être à l'origine de problèmes importants en matière d'équilibre budgétaire. Mais l'autonomie fiscale a un avantage majeur. Lorsque la politique monétaire n'est plus du ressort des pays et lorsque la politique budgétaire est contrainte par le Pacte de stabilité et de croissance, l'instrument fiscal devient le dernier outil macro-économique à la disposition des gouvernements pour absorber les chocs asymétriques. Le modèle proposé est construit sous deux horizons. Si l’horizon est fini, les conclusions traditionnelles de la littérature en faveur de l'harmonisation sont représentées. Avec un horizon infini, les joueurs prennent en compte les coûts de dévier et d'entrer dans une guerre d'usure. La coordination apparaît alors sans qu'il y ait besoin d'un mécanisme institutionnel pour la forcer.

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Paper provided by CREFE, Université du Québec à Montréal in its series Cahiers de recherche CREFE / CREFE Working Papers with number 132.

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Length: 20 pages
Date of creation: Apr 2001
Handle: RePEc:cre:crefwp:132
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  1. Kreps, David M & Wilson, Robert, 1982. "Sequential Equilibria," Econometrica, Econometric Society, vol. 50(4), pages 863-894, July.
  2. Boss, Alfred, 1999. "Do we need tax harmonization in the EU?," Kiel Working Papers 916, Kiel Institute for the World Economy (IfW).
  3. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  4. van Ypersele, T.P.M.C., 1998. "Coordination of Capital Taxation Among a Large Number of Asymmetric Countries," Discussion Paper 1998-137, Tilburg University, Center for Economic Research.
  5. Espinosa-Vega, Marco A & Yip, Chong K, 1994. "On the Sustainability of International Coordination," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(2), pages 383-396, May.
  6. Razin, Assaf & Sadka, Efraim, 1991. "International tax competition and gains from tax harmonization," Economics Letters, Elsevier, vol. 37(1), pages 69-76, September.
  7. Cardarelli, Roberto & Taugourdeau, Emmanuelle & Vidal, Jean-Pierre, 2002. " A Repeated Interactions Model of Tax Competition," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 4(1), pages 19-38.
  8. LOPEZ, Salvador & MARCHAND, Maurice & PESTIEAU, Pierre, "undated". "A simple two-country model of redistributive capital income taxation," CORE Discussion Papers RP 1411, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Torsten Persson & Guido Tabellini, 1992. "The Politics of 1992: Fiscal Policy and European Integration," Review of Economic Studies, Oxford University Press, vol. 59(4), pages 689-701.
  10. Holmlund, B. & Kolm, A.-S., 1999. "Economic Integration, Imperfect Competition, and International Policy Coordination," Papers 1999:7, Uppsala - Working Paper Series.
  11. Cremer, Helmuth & Gahvari, Firouz, 2000. "Tax evasion, fiscal competition and economic integration," European Economic Review, Elsevier, vol. 44(9), pages 1633-1657, October.
  12. Wilson, John Douglas, 1987. "Trade, Capital Mobility, and Tax Competition," Journal of Political Economy, University of Chicago Press, vol. 95(4), pages 835-856, August.
  13. Alfons Weichenrieder, 1996. "Fighting international tax avoidance," Fiscal Studies, Institute for Fiscal Studies, vol. 17(1), pages 37-58, February.
  14. Wildasin, David, 1993. "Fiscal competition and interindustry trade," Regional Science and Urban Economics, Elsevier, vol. 23(3), pages 369-399, July.
  15. Benoit, Jean-Pierre & Krishna, Vijay, 1985. "Finitely Repeated Games," Econometrica, Econometric Society, vol. 53(4), pages 905-922, July.
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