Gregoire Rota-Graziosi, Ph.D., Economics, Universite d'Auvergne, 65 boulevard François Mitterrand, Clermont-Ferrand, 63000, France
Oates (1972, p. 143) writes “In an attempt to keep taxes low to attract business investment, local officials may hold spending below those levels for which marginal benefits equal marginal cost.” Zodrow and Miezkowski (1986) and Wildasin (1988) have formalized this race-to-the-bottom. The latter consider large jurisdictions which can influence the after-tax rate of return on capital through their tax policy. In this paper we extend the standard model of horizontal tax competition of Wildasin (1988). Following the literature on the endogenous timing in duopoly games (Hamilton and Slutsky, 1990 or Amir and Stepanova, 2006), we consider a pre-play stage, where jurisdictions (countries or sub-national governments) commit themselves to lead or to follow. We highlight a second mover advantage in the Wildasin’s model. Moreover, we establish that the Nash equilibrium, which is widely studied in the literature on tax competition, is not a Perfect Sub-game Nash Equilibrium (PSNE) in pure strategies when jurisdictions are identical. Indeed, the two Stackelberg situations are the PSNE under symmetry assumption. We conclude that the race-to-the bottom is not as strong as predicted by the standard theoretical literature.
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