Dynamic Capital Tax Competition in a Two-country Model

Paul Klein

No 496, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: In this paper we explore the implications of tax competition between two jurisdictions in a neoclassical growth model under the assumption of perfect capital mobility. The government of each jurisdiction solves an optimal taxation problem under commitment, treating the other government's policies as given. We provide a new theoretical perspective on a dynamic capital-tax externality that emerges in this model. In numerical experiments, we find that, as a result of this externality, for a range of reasonable parameter values, source-based capital income tax rates are positive in the short run and zero in the long run. We find further that the convergence to zero is much slower than in a closed economy. The latter implies that taxes can be higher with capital mobility than without it, in contrast to a widely held consensus.

Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed014:496

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