Tax Competition with Heterogeneous Firms

21 Pages Posted: 9 May 2014 Last revised: 12 May 2014

See all articles by Richard E. Baldwin

Richard E. Baldwin

University of Geneva - Graduate Institute of International Studies (HEI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Toshihiro Okubo

Keio University

Date Written: May 1, 2014

Abstract

This paper studies tax competition in an economic geography model that allows for agglomeration economies with trade costs and heterogeneous firms. We find that the Nash equilibrium involves the large country charging a higher tax than the small nation, with this rate being too low from a social point of view. Lower trade costs lead to an intensification of competition, a drop in Nash tax rates, and a narrowing of the gap. Since large, productive firms are naturally more sensitive to tax differences in our model, large firms are the crux of tax competition in our model. This also means that tax competition has consequences for the average productivity of the big and small nations‟ industry; by lowering tax rates, the small nation can attract high-productivity firms.

Keywords: firm heterogeneity, spatial sorting, Nash equilibrium tax, tax cooperation, average productivity

JEL Classification: H32, P16

Suggested Citation

Baldwin, Richard E. and Okubo, Toshihiro, Tax Competition with Heterogeneous Firms (May 1, 2014). CAMA Working Paper No. 36/2014. Available at SSRN: https://ssrn.com/abstract=2434334 or http://dx.doi.org/10.2139/ssrn.2434334

Richard E. Baldwin

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland
+41 22 908 5933 (Phone)
+41 22 733 3049 (Fax)

HOME PAGE: http://www.hei.unige.ch/~baldwin/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Toshihiro Okubo (Contact Author)

Keio University ( email )

2-15-45 Mita
Minato-ku
Tokyo, 108-8345
Japan

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