Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit taxes

Haufler, Andreas and Stähler, Frank (2009): Tax competition in a simple model with heterogeneous firms: How larger markets reduce profit taxes. Discussion Papers in Economics 2009-19

Abstract

An important puzzle in corporate taxation is that effective tax rates have fallen significantly while tax revenue has simultaneously risen in most countries. Moreover, the gross profitability of firms seems to be lower in high-tax countries, even though standard models of international investment would yield the opposite conclusion. We offer an explanation for these stylized facts by setting up a simple two-country model of tax competition with heterogenous firms. In this model a unique, asymmetric Nash equilibrium can be shown to exist, provided that countries are sufficiently different with respect to their exogenous market conditions. In equilibrium the larger country levies the higher tax rate and attracts the high-cost firms. A simultaneous expansion of both markets intensifies tax competition and causes both countries to reduce their tax rates, despite higher corporate tax bases.

• Item Type: Paper (Discussion Paper)
• Status: Submitted Version
• Keywords: tax competition; heterogeneous firms; imperfect competition
• Collections: Economics; Economics > Discussion Papers in Economics; Economics > Discussion Papers in Economics > International Trade; Economics > Discussion Papers in Economics > Public Finance
• Subjects: 300 Social sciences > 300 Social sciences, sociology and anthropology; 300 Social sciences > 330 Economics
• JEL Classification: H25, H73, F15, F21
• Language: English