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Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit Taxes

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  • Haufler, Andreas
  • Stähler, Frank

Abstract

We set up a simple two-country model of tax competition where firms with different productivity decide in which location to produce and sell output. In this model, a unique, asymmetric Nash equilibrium is shown to exist, provided that countries are sufficiently different with respect to their exogenous market size. Sorting of firms occurs in equilibrium, as the smaller country levies the lower tax rate and attracts the low-cost firms. A simultaneous expansion of both markets that raises the profitability of firms intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.

Suggested Citation

  • Haufler, Andreas & Stähler, Frank, 2013. "Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit Taxes," Munich Reprints in Economics 20412, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenar:20412
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    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects
    • F15 - International Economics - - Trade - - - Economic Integration
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements

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