Tax Competition and Fiscal Sustainability

By constructing a two-country endogenous growth model with a debt-financing government, this study examines the relationship between the sustainability of public finance and increases in interregional factor mobility. To this end, it identifies the minimum tax rate that ensures fiscal sustainability in the tax competition environment and the effects of capital tax competition on fiscal sustainability. The main findings are as follows: (i) when countries are symmetric, increasing capital flows encourages accumulation of capital through tax reduction derived from tax competition and promotes economic growth through the expansion of Romer-type knowledge spillovers, resulting in increased fiscal sustainability in all countries; and (ii) when there are significant differences between countries in initial debt outstanding, tax competition might lower fiscal sustainability in a country that has a relatively large outstanding debt.