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The Effects of Tax Competition when Politicians Create Rents to Buy Political Support

  • Wolfgang Eggert

    (University of Paderborn)

  • Peter Birch Sørensen

    (Department of Economics, University of Copenhagen)

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    We set up a probabilistic voting model to explore the hypothesis that tax competition improves public sector efficiency and social welfare. In the absence of tax base mobility, distortions in the political process induce vote-maximising politicians to create rents to public sector employees. Allowing tax base mobility may be welfare-enhancing up to a point, because the ensuing tax competition will reduce rents. However, if tax competition is carried too far, it will reduce welfare by causing an underprovision of public goods. Starting from an equilibrium where tax competition has eliminated all rents, a coordinated rise in capital taxation will always be welfare-improving. For plausible parameter values it will even be welfare-enhancing to carry tax coordination beyond the point where rents to public sector workers start to emerge.

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    Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 07-04.

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    Length: 39 pages
    Date of creation: Dec 2007
    Date of revision:
    Handle: RePEc:kud:epruwp:07-04
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