The Importance of Government Commitment in Attracting Firms: A Dynamic Analysis of Tax Competition in an Agglomeration Economy

39 Pages Posted: 5 Jan 2014 Last revised: 7 Apr 2015

Date Written: September 1, 2014

Abstract

Agglomeration tendencies of industrial firms significantly affect the nature of tax competition. This paper analyzes tax competition between two countries over an infinite time horizon in an economy with trade costs and internationally mobile industrial firms. Most of the previous studies on tax competition in the `new economic geography' framework employ static models. In this study, two governments dynamically compete with each other to attract firms through their choices of taxes and subsidies. It is shown that the commitment of the governments to their policies is crucial in determining the distribution of firms in the long run. Specifically, if governments find each others' tax policies credible, then one country will attract all the firms when trade costs are low enough to make agglomeration forces dominant. If policies are not credible, both countries may attract an equal share of firms even when trade costs are low, as the lack of commitment by governments acts as a dispersion force.

Keywords: Economic geography; Tax competition; Forward-looking behavior; Differential game; Commitment

JEL Classification: F15, F22, H20, H30

Suggested Citation

Kato, Hayato, The Importance of Government Commitment in Attracting Firms: A Dynamic Analysis of Tax Competition in an Agglomeration Economy (September 1, 2014). Available at SSRN: https://ssrn.com/abstract=2374674 or http://dx.doi.org/10.2139/ssrn.2374674

Hayato Kato (Contact Author)

Osaka University ( email )

1-7 Machikaneyama
Toyonaka, Osaka 5600043
Japan

HOME PAGE: http://https://hayatokato.weebly.com/

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
105
Abstract Views
2,499
rank
279,163
PlumX Metrics