DP3607 Tax Competition and the Nature of Capital

Author(s): Richard Baldwin, Rikard Forslid
Publication Date: October 2002
Keyword(s): tax competition, tiebout hypothesis
JEL(s): F20, H20, H40
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3607

The standard race-to-the-bottom result is curious in one respect. If a nation wants to attract foreign capital, providing the optimal level of public amenities (and thus charging the optimal tax rate) would seem optimal. This conjecture fails in the standard tax competition model since foreign capital ignores host nation amenities. While this assumption is reasonable for physical capital, other forms of capital (human capital) tend to move with their owner, so amenities matter. We show that when factors move with their owners, symmetric international tax competition may leads to the socially optimal rate. This result can be thought of as a corollary of the Tiebout efficiency hypothesis.