Unemployment and endogenous choice on tax instruments in a tax competition model: unit tax versus ad valorem tax

Yuya Kikuchi and Toshiki Tamai
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Yuya Kikuchi: Chubu University

International Tax and Public Finance, 2024, vol. 31, issue 2, No 8, 533-551

Abstract: Abstract This paper examines the endogenous choice of unit and ad valorem taxes in a model of tax competition with unemployment. Governments maximize objective functions that are a weighted sum of regional welfare and revenue. In the tax competition model, a high fixed wage rate generates unemployment and employment externalities. This effect can be either positive or negative because of freely mobile capital among regions. Without unemployment, revenue-maximizing governments choose unit taxes as their tax instrument to avoid revenue losses from intense tax competition under ad valorem taxes. However, with unemployment, positive employment externalities generate additional benefits for using ad valorem taxes to stimulate employment. Therefore, the present study shows that one region chooses an ad valorem tax, whereas the other chooses a unit tax, or that both governments use ad valorem taxes depending on employment externalities.

Keywords: Tax competition; Unit tax; Ad valorem tax; Unemployment (search for similar items in EconPapers)
JEL-codes: H20 H21 H77 J64 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10797-023-09785-x

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