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A Quantitative Analysis of Tax Competition v. Tax Coordination under Perfect Capital Mobility

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  • Enrique G. Mendoza

    (University of Maryland and NBER)

  • Linda L. Tesar

    (University of Michigan and NBER)

Abstract

Theory predicts that strategically-determined tax rates induce negative externalities across countries in relative prices, the wealth distribution and tax revenue. This paper studies the interaction of these externalities in a dynamic, general equilibrium environment and its effects on quantitative outcomes of tax competition in one-shot games over capital income taxes between two governments that set time-invariant taxes and issue debt. Strategic payoffs correspond to welfare gains net of the cost of transitional dynamics in a standard neoclassical two-country model with exogenous balanced growth. The model is calibrated to European data for the early 1980s starting from a benchmark with symmetric countries. When countries compete over capital taxes adjusting labor taxes to maintain fiscal solvency, the Nash equilibrium replicates calibrated taxes, suggesting that European taxes can be the outcome of Nash competition. When consumption taxes are adjusted to maintain fiscal solvency, competition triggers a “race to the bottom” in capital taxes but this outcome is welfare-improving relative to calibrated taxes. Sensitivity analysis shows that competition can produce a “race to the top” in capital taxes and that the United Kingdom can benefit from tax competition with Continental Europe. Surprisingly, the gains from coordination in all of these experiments are small.

Suggested Citation

  • Enrique G. Mendoza & Linda L. Tesar, 2003. "A Quantitative Analysis of Tax Competition v. Tax Coordination under Perfect Capital Mobility," Working Papers 507, Research Seminar in International Economics, University of Michigan.
  • Handle: RePEc:mie:wpaper:507
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    References listed on IDEAS

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    Cited by:

    1. Julian di Giovanni & Andrei A. Levchenko, 2010. "Putting the Parts Together: Trade, Vertical Linkages, and Business Cycle Comovement," American Economic Journal: Macroeconomics, American Economic Association, pages 95-124.
    2. McAdam, Peter & Straub, Roland & Coenen, Günter, 2007. "Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model," Working Paper Series 747, European Central Bank.
    3. Coenen, Günter & McAdam, Peter & Straub, Roland, 2008. "Tax reform and labour-market performance in the euro area: A simulation-based analysis using the New Area-Wide Model," Journal of Economic Dynamics and Control, Elsevier, vol. 32(8), pages 2543-2583, August.
    4. Huizinga, Harry & Nielsen, Søren Bo, 2008. "Must losing taxes on saving be harmful?," Journal of Public Economics, Elsevier, pages 1183-1192.
    5. Eduardo Haddad & Alexandre A. Porsse & Eduardo P. Ribeiro, 2006. "Modeling Interjurisdictional Tax Competition in a Federal System," ERSA conference papers ersa06p359, European Regional Science Association.
    6. Günther Rehme, 2007. "Economic Growth and (Re-)Distributive Policies in a Non-cooperative World," Journal of Economics, Springer, pages 1-40.
    7. Huizinga, Harry & Nielsen, Søren Bo, 2008. "Must losing taxes on saving be harmful?," Journal of Public Economics, Elsevier, pages 1183-1192.
    8. Eva de Francisco, 2005. "Limited Participation, Income Distribution and Capital-Account Liberalization: Working Paper 2005-02," Working Papers 16302, Congressional Budget Office.
    9. Enrique G. Mendoza & Linda L. Tesar, 2003. "Winners and Losers of Tax Competition in the European Union," NBER Working Papers 10051, National Bureau of Economic Research, Inc.
    10. Souleymane COULIBALY, 2008. "Empirical Assessment of the Existence of Taxable Agglomeration Rents," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 08.01, Université de Lausanne, Faculté des HEC, DEEP.
    11. Günther Rehme, 2007. "Economic Growth and (Re-)Distributive Policies in a Non-cooperative World," Journal of Economics, Springer, pages 1-40.
    12. Eva de Francisco, 2005. "Limited Participation, Income Distribution and Capital Account Liberalization," Computing in Economics and Finance 2005 454, Society for Computational Economics.
    13. George Hondroyiannis, 2010. "Fertility Determinants and Economic Uncertainty: An Assessment Using European Panel Data," Journal of Family and Economic Issues, Springer, vol. 31(1), pages 33-50, March.
    14. Desai, Mihir A. & Foley, C. Fritz & Hines, James Jr., 2006. "Do tax havens divert economic activity?," Economics Letters, Elsevier, vol. 90(2), pages 219-224, February.

    More about this item

    JEL classification:

    • F2 - International Economics - - International Factor Movements and International Business
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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