Sensitivity Versus Size: Implications for Tax Competition

Abstract

The conventional wisdom is that a big jurisdiction sets a higher tax rate than a small jurisdiction. We show this result arises due to simplifying assumptions that imply tax-base sensitivities are equal across jurisdictions. When more than two jurisdictions compete in commodity taxes, taxbase sensitivities need not be equal across jurisdictions and a small jurisdiction can set a higher tax rate than a big jurisdiction. Our analysis extends to capital and profit taxes, and, more generally, to various types of multi-player asymmetric competition.

Keywords: Ramsey rule, inverse elasticity, fiscal competition, optimal taxation, spatial price competition, sales tax

JEL Classification: C700, D400, H200, H700, L100, R500