269 Abstract - A central message of the tax competition literature is that independent governments engage in wasteful competition for scarce capital through reductions in tax rates and public expendi- ture levels. This paper discusses many of the contributions to this literature, ranging from early demonstrations of wasteful tax com- petition to more recent contributions that identify efficiency- enhancing roles for competition among governments. Such roles involve considerations not present in earlier models, including im- perfectly-competitive market structures, government commitment problems, and political economy considerations. INTRODUCTION T he modern literature on tax competition began with an attempt to understand the potential efficiency problems associated with competition for capital by local governments. Oates (1972, p. 143) describes this problem as follows: “The result of tax competition may well be a tendency toward less than efficient levels of output of local services. In an at- tempt to keep taxes low to attract business investment, local officials may hold spending below those levels for which mar- ginal benefits equal marginal costs, particularly for those pro- grams that do not offer direct benefits to local business.” In other words, local officials will supplement the conven- tional measures of marginal costs with those costs arising from the negative impact of taxation on business investment. These additional costs might include lower wages and em- ployment levels, capital losses on homes or other assets, and reduced tax bases. Their presence will reduce public spend- ing and taxes to levels where the marginal benefits equal the higher marginal costs. Oates’s conclusion that this behavior is inefficient rests on the idea that when all governments be- have this way, none gain a competitive advantage, and con- sequently communities are all worse off than they would have been if local officials had simply used the conventional mea- sures of marginal costs in their decision rules. Since the mid-1980s, there has been an outpouring of aca- demic research on tax competition, and this research contin- ues unabated. Interest in this area has been stimulated by highly publicized instances where U.S. states and localities do seem to have engaged in tax competition, including the many cases where they have offered large subsidies to for- eign and domestic automobile companies in an attempt to Theories of Tax Competition John Douglas Wilson Department of Economics, Michigan State University, East Lansing, MI 48824
Theories of Tax Competition
Jul 04, 2023
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