Tax Competition for Automation Capital

Can national governments stop adverse effects of automation on workers from materializing in a world where capital is mobile? We tackle this question by studying tax competition between two governments for internationally mobile capital used in a non-automated sector and an automated sector, in the latter of which labor and capital are perfect substitutes in production. We compare the tax-competition outcome with the outcome in a closed economy without capital mobility and find contrasting results. In the closed-economy case, more efficient automation technology brings a higher wage to workers by allowing governments to choose a higher tax on capital and a lower tax on labor used in production. In the tax-competition case, however, the fear of capital relocation to countries with lower capital tax prevents each government from raising their capital tax and lowering their labor tax. Consequently, the wage paid to workers always declines and the social welfare may also decline if the governments prioritize the earnings of workers.