Tax Competition and Tax Coordination in an Optimum Income Tax Model

Bernd Huber

No 97-25, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: The paper uses the self-selection approach of Stiglitz (1982) to study tax competition and tax coordination in a many country-optimum income tax model. In the model, the government can impose a non-linear tax schedule on wage income and a (source-based) tax on mobile capital. In an uncoordinated equilibrium, it turns out that countries can use the capital tax instrument to weaken the self-selection constraint. The paper presents examples where positive and negative capital taxes are optimal from a single country perspective. For the case of CES production functions, the paper shows that the optimal capital tax is zero. - The paper also shows that, contrary to the standard tax competition model, the uncoordinated equilibrium can be efficient. If the wealth distribution (the endowments with capital among individuals), is egalitarian, a coordination of capital taxes does not affect welfare. For non-egalitarian wealth distributions, a coordinated increase in capital taxes can raise or lower welfare depending on the redistributive impact of a higher capital tax.

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