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Fiscal competition and public debt

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  • Janeba, Eckhard
  • Todtenhaupt, Maximilian

Abstract

The existing theoretical literature on fiscal competition has to a large extent ignored the role of government debt as a determinant of taxes and productive public spending. We develop a simple model of fiscal competition with government borrowing. If a default on government debt is no option, initial debt levels play no role in fiscal competition. This neutrality result is overturned when a default is possible. A government that is constrained in its borrowing due to a possible default responds optimally by lowering spending on durable public infrastructure, which in turn induces more aggressive tax setting. A rise in exogenous firm mobility reinforces the link between legacy debt and fiscal competition. Our model may help explain the observation that highly indebted countries in Europe have decreased corporate tax rates over-proportionally. Our model may also be useful for evaluating decentralization reforms in which the power to tax firms is devolved to lower levels of governments which differ in their initial debt levels.

Suggested Citation

  • Janeba, Eckhard & Todtenhaupt, Maximilian, 2016. "Fiscal competition and public debt," ZEW Discussion Papers 16-013, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  • Handle: RePEc:zbw:zewdip:16013
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    References listed on IDEAS

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    More about this item

    Keywords

    Asymmetric Tax Competition; Business Tax; Sovereign Debt; Inter-Jurisdictional Tax Competition;

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods

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