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Tax Competition for Heterogeneous Firms with Endogenous Entry

  • Ronald B. Davies

    ()

    (University of Oregon Economics Department)

  • Carsten Eckel

    ()

    (University of Goettingen)

This paper models tax competition for mobile firms that are differentiated by the amount of labor needed to cover fixed costs. Because tax competition affects the distribution of firms, it affects both relative equilibrium wages across countries and equilibrium prices. These in turn influence the equilibrium number of firms. From the social planner's perspective, optimal tax rates are harmonized, providing the optimal number of firms, and set such that income is efficiently distributed between private and public consumption. As is common in tax competition models, in the Nash equilibrium tax rates are inefficiently low, yielding underprovision of public goods. Furthermore, there exist a variety of situations in which equilibrium tax rates differ. As a result, too many firms enter the market as governments compete to be the low-tax, high-wage country. This illustrates a new distortion from tax competition and provides an additional benefit from tax harmonization.

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Paper provided by University of Oregon Economics Department in its series University of Oregon Economics Department Working Papers with number 2007-6.

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Length: 41
Date of creation: 02 Mar 2007
Date of revision:
Handle: RePEc:ore:uoecwp:2007-6
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  1. Richard E. Baldwin & Paul Krugman, 2002. "Agglomeration, Integration and Tax Harmonization," NBER Working Papers 9290, National Bureau of Economic Research, Inc.
  2. Andreas Haufler & Ian Wooton, . "Country Size and Tax Competition for Foreign Direct Investment," Working Papers 9702, Business School - Economics, University of Glasgow.
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  9. Horst Raff, 2002. "Preferential Trade Agreements and Tax Competition for Foreign Direct Investment," CESifo Working Paper Series 763, CESifo Group Munich.
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