SFB 303 Discussion Paper No. A - 513
Author: Janeba, Eckhard
Title: Tax Competition in Imperfectly Competitive Markets
Abstract: The literature on strategic trade policy has shown that in imperfectly
competitive markets governments have an incentive to subsidize exports of
their own firms. Yet the consequence of the departure from laissez faire is
a wasteful subsidy race. In contrast, this paper shows that even in
imperfectly competitive markets there is a strong tendency for laissez-faire
to prevail. The driving force is the firms' willingness to exploit tax or
subsidy differentials by relocating production. A small tax differential
induces firms to change their place of production. The change in market
structure has a negligible effect on the oligopoly equilibrium, but a
non-negligible impact on government revenues. When tax policy is
non-discriminatory, governments gain (lose) by attracting all firms when
production is taxed (subsidized). Hence, laissez-faire is the only
equilibrium. Since from the point of view of the two producing countries
laissez-faire (nondiscrimination) Pareto dominates the intervention
equilibrium (discrimination), nondiscrimination is a simple device to result
in a mutual beneficial outcome.
Keywords: Tax Competition, Strategic Trade Theory, Imperfect Competition
JEL-Classification-Number: F12, H73
Creation-Date: August 1996
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