The name is absent

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

Wolfgang Eggert^t and Peter Birch S0rensen^t

4th December 2007

Abstract

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. Al-
lowing tax base mobility may be welfare-enhancing up to a point, because
the ensuing tax competition will reduce rents. However, if tax competi-
tion 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 al-
ways 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.

JEL classification: D72, H73, H87

Keywords: tax competition, rent seeking, probabilistic voting.

Address for correspondence:

Peter Birch S0rensen

Department of Economics, University of Copenhagen
Studiestraede 6, 1455 Copenhagen K, Denmark
E-mail: [email protected]

^University of Paderborn and CESifo.

+University of Copenhagen, EPRU and CESifo.

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