SUBSIDIES AS OPTIMAL FISCAL STIMULI

Theoretical macroeconomic models typically take fiscal policy to mean tax‐and‐spend by a ‘benevolent government’ that exploits potential aggregate demand externalities inherent in the imperfectly competitive nature of goods markets. Whilst shown to raise aggregate output and employment, these policies crowd‐out private consumption and typically reduce welfare. On account of their widespread use to stimulate economic activity, we consider the use of ‘tax‐and‐subsidize’ instead of ‘tax‐and‐spend’ policies. Within a static general equilibrium macro‐model with imperfectly competitive goods markets, we examine the effects of wage and output subsidies and show that, for a small open economy, positive tax and subsidy rates exist which maximize welfare, rendering no intervention suboptimal. We also show that, within a two‐country setting, a Nash non‐cooperative symmetric equilibrium with positive tax and subsidy rates exists, and that cooperation between governments in setting these rates is more expansionary and leads to an improvement upon the non‐cooperative solution.     

A spatial tax harmonization model

Policies to harmonize value-added tax rates are controversial in the European Union. This paper formulates a multi-country model over a one-dimensional space as a non-cooperative Nash game, in which each country aims at maximizing its tax revenue, subject to the constraint that its tax rate lies within a given common band. Then we examine the effects of changes in the common band on tax rates, tax revenues and the number of cross-border shoppers at Nash equilibrium. We also analyze the effects of geographical variation in country size and location.     

A Public Choice Approach to Strategic and Nonstrategic Environmental Policy

In this paper we take a public choice perspective on strategic environmental policy and international environmental agreements. We examine cooperative and noncooperative environmental policies under governments that are either welfare maximizers (“good dictators”) or tax revenue maximizers (“Leviathans”). We show that Leviathans can perform better in terms of welfare and that good dictators can set higher taxes. We then analyze international environmental agreements and show that the breakdown of environmental cooperation can indeed lead to a welfare gain for all signatory countries. Considering a delegation game between governments, we find that a Pareto‐superior Leviathan outcome can be the unique Nash equilibrium.     

Brain Drain,Fiscal Competition,and Public Education Expenditure

A two‐country model is developed in this paper to examine the implications of fiscal competition in public education expenditure under international mobility of high‐skilled labor. The authors allow for educational choice, asymmetry of countries with respect to total factor productivity, and tax base effects of migration in source and host country. As the latter may give rise to multiplicity of equilibrium, alternative belief structures of mobile high‐skilled workers are carefully taken into account. The paper also looks at the consequences of bilateral policy coordination. While in line with other studies on tax competition, bilateral coordination can reduce the under‐investment problem in public education spending, it also tends to hinder migration or may even reverse the direction of the migration flow that materializes under non‐cooperative policy setting. As a result of its potentially adverse effects on migration patterns, bilateral coordination may therefore reduce global welfare and bring the world economy further away from the social planner's solution.     

Sorting by foot: 'travel‐for' local public goods and equilibrium stratification

Abstract.  We re‐examine Tiebout's hypothesis of endogenous sorting in a competitive spatial equilibrium framework, by considering both income and preference heterogeneity and by allowing agents to decide endogenously the number of visits to a 'travel‐for' local public good. The equilibrium configuration may be completely segregated, incompletely segregated, or completely integrated, depending on relative market rents and income/preference/local tax parameters. A segregated equilibrium may feature endogenous sorting purely by income or by both income and preferences. While the rich need not be closer to the local public facility site, multiple equilibria may arise when the equilibrium configuration is incompletely segregated. JEL classification: D50, H41     

Pareto-Improving Redistribution and Pure Public Goods

In the pure public good model, the Nash equilibrium associated with one initial income distribution may Pareto dominate the equilibrium associated with another distribution of the same aggregate income. We explore this possibility and examine its implications for Pareto-improving policy intervention by undertaking a comparative static analysis of Pareto-improving tax-financed increases in pure public good provision. Under some circumstances, a government can engineer policies that raise public good provision while increasing the well-being of contributors and non-contributors. Crucial factors promoting this outcome involve a large number of non-contributors, a high marginal valuation for the public good by non-contributors and a large aggregate response of contributors to changes in their income.     

Transfer pricing rules and corporate tax competition

A multinational parent sells a non-marketed commodity to a foreign subsidiary that uses the product as an input to produce a product it then sells. The subsidiary is controlled by a local managing partner whose compensation consists of a lump-sum payment plus a share of the subsidiary's profit. The parent chooses an optimal transfer price taking into account incentives for the subsidiary's managing partner and taxes. Home and host governments impose corporate income taxes on the parent and subsidiary's respective profits subject to a transfer pricing rule (e.g. cost plus price method or comparable profit method). A Nash equilibrium is derived for effective tax rates chosen by home and host governments. We then examine harmonization and suggest that tax rates would be reduced.     

A graphic representation of the Nash and Lindahl equilibria in an economy with a public good

In an economy with a public good the noncooperative Nash equilibrium and the cooperative Lindahl equilibrium are represented graphically. The Nash equilibrium is shown to be non-optimal, while the Lindahl equilibrium is shown to be optimal. Simple stability analyses are undertaken. Finally, the two equilibria are compared. It appears that more public good will be allocated in the Lindahl than in the Nash equilibrium, and that in a sufficiently large economy a transition from a Nash to a Lindahl equilibrium will be advantageous for everyone.     

Which border taxes? Origin and destination regimes with fiscal competition in output and emission taxes

This paper posits a two-stage game in tax regime and tax rates to study the property of second-best emission and output taxes in a two-country world with an atmospheric externality. It shows that (i) either the destination–destination or the origin–origin tax regime may constitute the subgame perfect Nash equilibrium of this game; (ii) either regime may Pareto-dominate the other; (iii) it is possible to have a prisoner's dilemma game where the origin–origin regime Pareto-dominates but the choice of the destination regime is the dominant strategy for each country. Other results include (iv) under origin–origin regime: the output tax is used for fiscal competition; the emission tax is set at a rate equal to the (national) marginal social damage of emissions; and public goods are provided suboptimally. (v) Under destination–destination regime: the output tax is ineffective as an instrument for fiscal competition; the emission tax is used not only for combating pollution but also for tax competition; the tax is set at a rate below the (national) marginal social damage of emissions; emissions are pushed above their closed-economy level; the provision of public goods are optimal.     

The trade paradox persists under excise taxes

Brander and Krugman (1983) and Sertel (1988) followed by Krugman (1989), showed two sides of a ‘trade paradox’: The paradox in competition, viz. that opening trade (or increasing competition) may cause welfare to decline, and the paradox in efficiency, viz. that an increase in unit transport cost may increase welfare. In this paper, we consider the situation in an environment where interventionist trade policies are not permitted but each country is sovereign to impose an excise tax (or subsidy). The paradoxes persist under equilibrium excise taxes, reckoned both at the non-cooperative (Nash or dominant strategy) equilibrium and at the cooperative solution among tax-imposing authorities maximizing welfare. We also see that the paradoxes persist in a taxless environment where market equilibrium is Stackelberg rather than Cournot.     

Efficient Migration and Income Tax Competition

This paper examines the consequence of the brain drain for the income tax systems of the source and destination countries for the migration, if the two countries' policies are set noncooperatively by self–interested voters. It is assumed that the brain drain does increase the value of world output: workers with the highest income–earning ability are assumed to be more productive in one country than in another. There are costs to migration of these high–ability workers, costs that are less than the gain in the value of their production. However, for lower–ability workers, the gains in production in moving from the low–productivity country to the high–productivity country are assumed to be less than the migration costs. Voters in the high–productivity country want to capture rents from migrants. These voters are aware of the influence their tax policy has on people's migration decisions. Voters in the low–productivity country also behave strategically. I solve for the Nash equilibrium income tax rates. Increased mobility of highly skilled workers cannot decrease, and may increase, progressivity in the income tax system of the destination country, if migration actually occurs. Finally, the effects of transfers between countries on their income tax systems are examined. Redistribution between countries tends to lead to less redistribution within countries. If transfers between countries are set by a vote of all residents of both countries, then the transfer chosen will be the one that leads to the least progressive tax possible being chosen in each country.     

Optimal taxation, global externalities and labor mobility

This paper concerns transboundary environmental problems in the context of an optimal tax model. We assume that part of the labor force is mobile across countries, and that the set of tax instruments includes a nonlinear income tax and a commodity tax on the ‘dirty’ good that is causing damage to the environment. The purpose is to compare the (globally optimal) second best policy of a cooperative equilibrium with the policy implicit in a noncooperative equilibrium. We show that the commodity taxes differ between equilibria because of: (i) transboundary externalities not internalized by national governments, (ii) interaction effects between environmental and other policies, and (iii) labor mobility.     

International tax arbitrage and residence vs. source-based capital income taxation

Using a two-country general equilibrium framework with heterogeneous agents and uncertainty, we examine how countries' adoption of different fundamental approaches to taxing international capital income will affect portfolio choices and pricing relationships in international bond and foreign exchange markets. We characterize an equilibrium where (tax-)arbitrageurs in the country applying the source principle may exploit the resulting tax arbitrage opportunities up to some individual bound, normal investors in either country refrain, or are restrained, from constructing such (tax-)arbitrage portfolios, while arbitrageurs in the country using the residence principle do not share in any tax arbitrage profits.     

Capital Tax Competition and Cooperation with Endogenous Capital Formation

Incorporating consumption–savings choices under a general concave utility function and hence an endogenous capital supply into a model of capital tax competition, we re‐investigate Nash equilibrium and compare it with the optimum under cooperative tax policy. In contrast to the case of fixed capital supply, it is shown that if savings sufficiently increase with the interest rate, a Nash equilibrium may be more efficient than a cooperative tax policy. Therefore, the distortionary effects of capital supply are important to issues of tax policy coordination.     

Withholding taxes or information exchange: the taxation of international interest flows

This paper considers withholding taxes and information exchange as alternative means to tax international interest income. For each regime, we consider the maximum level of taxation of foreign-source income that can be sustained as the equilibrium of a repeated game. The best regime is the one that brings the level of taxation in the repeated game closest to the cooperative level of interest taxation. Sustainable levels of taxation in either regime depend on the importance of bank profits and on the marginal cost of public funds, among other things. Simulations with the model illustrate the choice between withholding taxes and information exchange. An explicit possibility is the emergence of a mixed regime, with one country imposing a withholding tax and the other country providing information. The basic model is extended to allow for size differences between the two countries and to incorporate a third, outside country.     

On the Frequency of Interior Cournot–Nash Equilibria in a Public Good Economy

In a public good economy the distribution of initial income is an important determinant of how many individuals contribute to the public good in Cournot–Nash equilibrium. In this paper, first a simple formula is derived that provides a measure for the size of the set of income distributions leading to an interior Cournot–Nash equilibrium in which all individuals contribute to the public good. Furthermore, we give an estimate for the frequency that all members of a certain subgroup of the population are contributors.     

Asymmetric Tax Policy Responses in Large Economies With Cross-Border Pollution

We build a model of cross-border pollution between two large open economies, one importing the polluting good and the other exporting it, and derive their non-cooperative trade and environmental tax policies. We show among other things, that (1) in response to a bilateral reduction in trade taxes by both countries, the former country’s optimal policy is to lower its Nash emissions tax while the latter’s is to raise it, and (2) in response to an increase in emissions tax rates by both countries, the former country’s optimal reaction is to raise its Nash import tariff, while the latter’s is to reduce its Nash export tax. That is, in the present context, freer trade leads the exporting country to adopt stricter while the importing country laxer environmental tax policies.     

TAX COMPETITION IN A SIMPLE MODEL WITH HETEROGENEOUS FIRMS: HOW LARGER MARKETS REDUCE PROFIT TAXES*

We set up a simple two‐country model of tax competition where firms with different productivity decide in which location to produce and sell output. In this model, a unique, asymmetric Nash equilibrium is shown to exist, provided that countries are sufficiently different with respect to their exogenous market size. Sorting of firms occurs in equilibrium, as the smaller country levies the lower tax rate and attracts the low‐cost firms. A simultaneous expansion of both markets that raises the profitability of firms intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.     

Federal transfers, environmental policy and economic growth

We study the effects of commonly used cross-country transfer programs on uncoordinated national environmental policies, economic growth and natural resources in a federal economy. Natural resources are a federation-wide public good. In each member country, production degrades the environment, but clean-up policy can improve it. Clean-up policy is financed by taxes on polluting firms’ output and cross-country redistributive transfers. We solve for a symmetric Nash equilibrium among national governments. Transfer policies that lead to higher pollution taxes make existence harder, and are harmful not only to growth but also to the environment. The best way to improve environmental quality is to implement a taxation system that stimulates growth and broadens tax bases to finance national clean-up policies.     

Why Free Trade May Hurt Developing Countries

This paper builds a general equilibrium trade model where a country produces two traded goods and one nontraded public consumption good. The government finances the provision of the public good by taxing the incomes of factors of production, and/or by imposing tariffs. Within this framework, the paper (i) shows that a small tariff or an income tax improves the country's welfare if there is an undersupply of public good, and (ii) identifies the circumstances in which an improvement in the country's terms of trade may reduce its welfare, and free trade can be inferior to autarky. A terms of trade improvement, or the movement from autarky to free trade, definitely improves the country's welfare if the government imposes a tariff that leaves the domestic relative price of the imported good unchanged.