Tax Policy Design in a Globalized Economy: A Comparative Analysis of Destination and Origin Principles

This paper is a model of an open economy in two countries in which we answer the question of whether the non-cooperative indirect tax should be in the country of consumption or the country of production. In this paper, each country has skilled and unskilled labor used in the production of differentiated goods in a monopolistically competitive economy. When a country raises its tax level, this causes both cross-border movement of firms and changes in labor and capital income, influencing welfare at home and abroad. We show that if in a country skilled labor is used more intensively than unskilled labor in the production of differentiated goods, the non-cooperative tax levied in the country of production leads to higher welfare than that levied in the country of consumption. The opposite is true if the country uses unskilled labor more intensively in the production of differentiated goods.