Tax Competition with Mobile Labor, Residents, and Capital

Abstract

We construct a unifying model of optimal decentralized policymaking that includes multiple tax and spending policies with mobile workers, mobile residents, and mobile capital. Local governments are atomistic with respect to the world capital market, but are linked by commuting patterns, the cost of which is endogenously determined by congestion. Commuting gives rise to “tax exporting,” with a higher capital tax in the (central) city partially borne by non-resident commuters from the suburbs, allowing the capital tax to remain optimal even when head taxes are available. More generally, employment-based taxes are valuable instruments only when jurisdictions are net recipients of commuters, while jurisdictions that are net providers of commuters will choose to rely on the use of residential-based taxes. Jurisdictions can combine labor and resident taxes to effectively tax commuters. Even though jurisdictions are price-takers in the world capital market, they strategically react to the policies of other small jurisdictions due to commuting linkages.

Keywords: tax competition, local governments, commuting, labor mobility

JEL Classification: H2, H4, H7, R5