Relaxing Tax Competition through Public Good Differentiation

Abstract

This paper argues that, because governments are able to relax tax competition through public good differentiation, traditionally high-tax countries have continued to set taxes at a relatively high rate even as markets have become more integrated. The key assumption is that there is variation in the extent to which firms can use public good provision to reduces costs. We show that, in a setting where tax competition promotes efficiency, governments are able to use this variation to relax the forces of tax competition, which reduces efficiency. In this environment, a `minimum tax' counters the relaxation of tax competition, thereby enhancing efficiency, and `split the difference' tax harmonization also enhances efficiency.