Monday, January 14, 2008

Tax Base Mobility

A paper of interest to some readers, perhaps.

The Effects of Tax Competition When Politicians Create Rents to Buy Political Support

Wolfgang Eggert & Peter Birch Sørensen
Journal of Public Economics, forthcoming

We set up a probabilistic voting model to explore the hypothesis that tax competition improves public sector efficiency and social welfare. In the absence of tax base mobility, distortions in the political process induce vote-maximising politicians to create rents to public sector employees. Allowing tax base mobility may be welfare-enhancing up to a point, because the ensuing tax competition will reduce rents. However, if tax competition is carried too far, it will reduce welfare by causing an underprovision of public goods. Starting from an equilibrium where tax competition has eliminated all rents, a coordinated rise in capital taxation will always be welfare-improving. For plausible parameter values it will even be welfare- enhancing to carry tax coordination beyond the point where rents to public sector workers start to emerge.

Some thoughts:

1. "Allowing" tax base mobility? Like when East Germans couldn't leave? There are lots of reasons for mobility, and emigration.
2. It is clear why a "coordinated rise in capital taxation" improves welfare. Unless you are an owner of capital. Then it is harder to see why this is a Pareto-improvement. I can see why it would be POLITICALLY expedient. But if all owners of capital are ALSO better off....well, I will need to figure out what feature of the model produces this result.