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Tax Competition with Heterogeneous Firms


  • Richard E. Baldwin
  • Toshihiro Okubo


This paper studies tax competition in an economic geography model that allows for agglomeration economies with trade costs and heterogeneous firms. We find that the Nash equilibrium involves the large country charging a higher tax than the small nation, with this rate being too low from a social point of view. Lower trade costs lead to an intensification of competition, a drop in Nash tax rates, and a narrowing of the gap. Since large, productive firms are naturally more sensitive to tax differences in our model, large firms are the crux of tax competition in our model. This also means that tax competition has consequences for the average productivity of the big and small nations? industry; by lowering tax rates, the small nation can attract high-productivity firms.

Suggested Citation

  • Richard E. Baldwin & Toshihiro Okubo, 2014. "Tax Competition with Heterogeneous Firms," CAMA Working Papers 2014-36, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:een:camaaa:2014-36

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    References listed on IDEAS

    1. Okubo, Toshihiro, 2009. "Trade liberalisation and agglomeration with firm heterogeneity: Forward and backward linkages," Regional Science and Urban Economics, Elsevier, vol. 39(5), pages 530-541, September.
    2. Fredrik Andersson & Rikard Forslid, 2003. "Tax Competition and Economic Geography," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 279-303, April.
    3. Trionfetti, Federico, 2001. "Public Procurement, Market Integration, and Income Inequalities," Review of International Economics, Wiley Blackwell, vol. 9(1), pages 29-41, February.
    4. Andreas Haufler & Frank Stähler, 2013. "Tax Competition In A Simple Model With Heterogeneous Firms: How Larger Markets Reduce Profit Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 54(2), pages 665-692, May.
    5. Ludema, Rodney D. & Wooton, Ian, 2000. "Economic geography and the fiscal effects of regional integration," Journal of International Economics, Elsevier, vol. 52(2), pages 331-357, December.
    6. Kind, Hans Jarle & Knarvik, Karen Helene Midelfart & Schjelderup, Guttorm, 2000. "Competing for capital in a 'lumpy' world," Journal of Public Economics, Elsevier, vol. 78(3), pages 253-274, November.
    7. Richard E. Baldwin & Toshihiro Okubo, 2006. "Heterogeneous firms, agglomeration and economic geography: spatial selection and sorting," Journal of Economic Geography, Oxford University Press, vol. 6(3), pages 323-346, June.
    8. Richard E. Baldwin & Toshihiro Okubo, 2014. "International Trade, Offshoring and Heterogeneous Firms," Review of International Economics, Wiley Blackwell, vol. 22(1), pages 59-72, February.
    9. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(2), pages 269-304, June.
    10. Okubo, Toshihiro & Picard, Pierre M. & Thisse, Jacques-François, 2010. "The spatial selection of heterogeneous firms," Journal of International Economics, Elsevier, vol. 82(2), pages 230-237, November.
    11. Baldwin, Richard E. & Krugman, Paul, 2004. "Agglomeration, integration and tax harmonisation," European Economic Review, Elsevier, vol. 48(1), pages 1-23, February.
    12. Zodrow, George R. & Mieszkowski, Peter, 1986. "Pigou, Tiebout, property taxation, and the underprovision of local public goods," Journal of Urban Economics, Elsevier, vol. 19(3), pages 356-370, May.
    13. Wilson, John D., 1986. "A theory of interregional tax competition," Journal of Urban Economics, Elsevier, vol. 19(3), pages 296-315, May.
    14. Forslid, Rikard & Midelfart, Karen Helene, 2005. "Internationalisation, industrial policy and clusters," Journal of International Economics, Elsevier, vol. 66(1), pages 197-213, May.
    15. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    16. Richard Baldwin & Toshihiro Okubo, 2009. "Tax Reform, Delocation, and Heterogeneous Firms," Scandinavian Journal of Economics, Wiley Blackwell, vol. 111(4), pages 741-764, December.
    17. Martin, Philippe & Rogers, Carol Ann, 1995. "Industrial location and public infrastructure," Journal of International Economics, Elsevier, vol. 39(3-4), pages 335-351, November.
    18. Ottaviano, Gianmarco & van Ypersele, Tanguy, 2002. "Market Access and Tax Competition," CEPR Discussion Papers 3638, C.E.P.R. Discussion Papers.
    19. Wilson, John Douglas, 1999. "Theories of Tax Competition," National Tax Journal, National Tax Association, vol. 52(n. 2), pages 269-304, June.
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    Cited by:

    1. repec:kap:itaxpf:v:24:y:2017:i:2:d:10.1007_s10797-016-9419-y is not listed on IDEAS
    2. Kato, Hayato, 2015. "The importance of government commitment in attracting firms: A dynamic analysis of tax competition in an agglomeration economy," European Economic Review, Elsevier, vol. 74(C), pages 57-78.
    3. Federica Liberini, 2014. "Corporate Taxes and the Growth of the Firm," KOF Working papers 14-354, KOF Swiss Economic Institute, ETH Zurich.
    4. Langenmayr Dominika, 2015. "Limiting Profit Shifting in a Model with Heterogeneous Firm Productivity," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 15(4), pages 1657-1677, October.
    5. Liberini, Federica, 2014. "Corporate Taxes and the Growth of the Firm," The Warwick Economics Research Paper Series (TWERPS) 1042, University of Warwick, Department of Economics.

    More about this item


    firm heterogeneity; spatial sorting; Nash equilibrium tax; tax cooperation; average productivity;

    JEL classification:

    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • P16 - Economic Systems - - Capitalist Systems - - - Political Economy of Capitalism

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