The name is absent

follows that the marginal rate of substitution g⁰ (G) /u⁰ (W + rk} is driven above
the marginal rate of transformation FL (α), so public goods become under provided
from the viewpoint of public sector workers. However, since the higher capital tax
rate causes a drop in r (see (2.13)) and a resulting fall in the private consumption
of private sector workers, their marginal rate of substitution g⁰ (G) /u⁰ (w + rk}
will fall below FL (α), so public goods will become over provided from the per-
spective of private sector workers.

3.2. Tax competition, rent destruction and public goods provision

Consider next the role of tax competition, i.e. the case where n>1 so that the
tax base elasticity becomes positive, due to international capital mobility. From
(3.1) we can show

Proposition 2: Tax competition will completely eliminate rents to public sector
employees if the political equilibrium under tax competition implies

^ε > μ α+7 ) (1 - n ´.                     (3.3)

Proof: See Appendix 2.

The condition in (3.3) is very intuitive: the higher is the tax base elasticity ε,
the higher is the marginal cost of public funds, so the more costly (in economic and
political terms) it is for politicians to raise taxes to finance rents to public sector
employees. Hence, if the political distortion in favour of public sector insiders is
not too high (so that the fraction (α++δ) in (3.3) is not too big), tax competition
will prevent rent creation.

However, while tax competition may provide an institutional defence against
rent seeking, as emphasized by the Public Choice school, it will also distort the
supply of public goods, as claimed by the traditional Public Finance school. This
is reflected in

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