Academic journal article Economic Inquiry

On the Desirability of Tax Coordination When Countries Compete in Taxes and Infrastructure

Academic journal article Economic Inquiry

On the Desirability of Tax Coordination When Countries Compete in Taxes and Infrastructure

Article excerpt


The debate over corporate tax coordination among international jurisdictions remains unresolved. In particular, it has been argued that the member states of the European Union (EU) should coordinate tax policies (1) to avoid a race to the bottom that would undermine their modern welfare states (Baldwin and Krugman 2004). (2)

The classical approach on tax coordination (see, e.g., Baldwin and Krugman 2004; Kanbur and Keen 1993) takes it for granted that jurisdictions compete in taxes only and do not consider other nontax variables as possible additional and independent instruments to attract tax bases. However, several authors argue that jurisdictions not only compete in taxes but also in infrastructure (e.g., Hindriks, Peralta, and Weber 2008; Justman, Thisse, and Ypersele 2002; Pieretti and Zanaj 2011; and Zissimos and Wooders 2008). Moreover, recent empirical research (Hauptmeier, Mittermaier, and Rincke 2012) demonstrates that jurisdictions use independent and strategic business tax rates and public inputs to compete for capital.

Therefore, when jurisdictions can compete with tax and nontax instruments independently, constraining tax rates through tax coordination is likely to create carry-over effects on other strategic instruments, thus creating adverse effects not considered in the classical approach. Against this background, it is interesting to reconsider tax coordination.

There are some authors (Fuest 1995; Keen and Marchand 1997) who consider the impact of public inputs on the production function of firms and thus account for the effect of infrastructure on internationally mobile capital. However, in these models, tax rates and infrastructure expenditures are not perfectly independent endogenous variables. The tax rate and infrastructure expenditures can be endogenous only if public consumption is also endogenous. In other words, with two instruments and the requirement to balance the government's budget, only one policy instrument can be set strategically (Hauptmeier, Mittermaier, and Rincke 2012). Moreover, in these contributions, there are no strategic interactions between the competing countries because they are small. (3)

The purpose of this article is to analyze the desirability of tax coordination when two heterogeneous jurisdictions compete for mobile entrepreneurs using taxes and infrastructure investments that improve firm productivity. (4) These infrastructure investments may represent material or immaterial public goods such as laws and regulations protecting intellectual property and specifying accurate dispute resolution rules.

The literature generally highlights two different ways to coordinate taxation (5) in order to correct the inefficiencies (6) caused by tax competition: tax harmonization and the imposition of a minimum tax rate. Tax harmonization is generally understood as a transition towards a common rate structure (Keen 1987; Zissimos and Wooders 2008). More specifically, in the present paper, we define tax harmonization as the equalization of tax rates, which is consistent with the tax competition literature (see, e.g., Baldwin and Krugman 2004; Kanbur and Keen 1993; Zissimos and Wooders 2008) and common policy prescriptions. (7) The general conclusion of the classical literature is that appropriately selected uniform tax rates improve efficiency relative to tax competition. The reason is that an upward harmonization of capital tax rates can produce a Pareto improvement (Baldwin and Krugman 2004). This conclusion also holds when the competing countries are asymmetric in size (Kanbur and Keen 1993). (8) Another type of coordination is the adoption of a minimum tax rate that allows some room for tax competition. An interesting result highlighted in the literature (see Kanbur and Keen 1993) is that the imposition of a minimum tax rate can be Pareto-improving.

A related paper to ours is Zissimos and Wooders (2008). …

Search by... Author
Show... All Results Primary Sources Peer-reviewed


An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.