Tax Competition and Economic Geography

Tax competition between two countries is considered in a trade-and-location setting with differentiated products and monopolistic competition. There are two groups of workers, mobile ones and immobile ones. Taxes are used for producing a public good. It is shown that an equilibrium with mobile workers dispersed across countries is destabilised by increased taxes on these mobile workers---and this is shown to be true also for perfectly coordinated tax increases. It is also shown that an agglomeration is taxable, and that increasing public spending may relax the minimum tax pressure on immobile workers consistent with preserving an agglomeration.