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Agglomeration, Integration and Tax Harmonization

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Abstract

This paper considers tax competition and tax harmonization in the presence of agglomeration forces and falling trade costs. With agglomerative forces operating, industry is not indifferent to location in equilibrium, so perfectly mobile capital becomes a quasi-fixed factor. This suggests that the tax game is something subtler than a race to the bottom. Advanced 'core' nations may act like limit-pricing monopolists toward less advanced 'periphery' countries. Consequently, integration need not lead to falling tax rates, and might well be consistent with the maintenance of large welfare states. "Limit taxing" also means that that simple tax harmonization - adoption of a common tax rate - always harms at least one nation and adoption of a rate between the two unharmonised rates harms both nations. A tax floor set at the lowest equilibrium tax rate leads to a weak Pareto improvement.

Suggested Citation

  • Richard Baldwin; Paul Krugman, 2001. "Agglomeration, Integration and Tax Harmonization," IHEID Working Papers 01-2001, Economics Section, The Graduate Institute of International Studies.
  • Handle: RePEc:gii:giihei:heiwp01-2001
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    Keywords

    Tax Competition; Tax Harmonization; New Economic Geography; Geography; Agglomeration; Trade; European Integration;

    JEL classification:

    • H00 - Public Economics - - General - - - General
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods

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