Tax Competition with Heterogeneous Firms


This paper studies tax competition in a setting that allows for agglomeration economies and heterogeneous firms. We find that the Nash equilibrium involves the large country charging a higher tax than the small nation, with this rate being too low from a social point of view. Tighter integration of markets leads to an intensification of competition, a drop in Nash tax rates, and a narrowing of the gap. Since large, productive firms are naturally more sensitive to tax difference in our model, large firms are the crux of tax competition in our model. This also means that tax competition has consequences for the average productivity of the big and small nations' industry; by lowering tax rates, the small nation can attract high-productivity firms.

Keywords: Firm heterogeneity, Nash equilibrium tax, Stackelberg equilibrium tax, collusion, average productivity

JEL Classification: H32; P16;

Richard E. BALDWIN
Graduate Institute, Geneva

Toshihiro OKUBO
Research Institute for Economics and Business Administration
Kobe University
Rokkodai-cho, Nada-ku, Kobe
657-8501 Japan
Phone: (81) 78 803 7036
Fax: (81) 78 803 7059