from the proof of Proposition 2 stated in Appendix 3 that the public sector re-
cruitment constraint W ≥ w is in fact strictly binding. Using this insight, and
noting that (3.3) reduces to ε > δ/ (α + δ) for n → ∞, we can establish
Proposition 4: Starting from a tax competition equilibrium where ε > δ/ (α + δ)
so that all rents have been eliminated and the public sector recruitment constraint
W ≥ w is strictly binding, the government of a small country will want to spend
all of the extra revenue from an internationally coordinated rise in taxation on
additional public goods provision and will not want to create rents to public sector
employees.
Proof: See Appendix 3.
According to Proposition 4, under the plausible assumption that ε>
δ/ (α + δ), tax competition in the initial political eqilibrium preceding the in-
ternational agreement has reduced public goods provision to such an extent that
it is not politically expedient for national governments to use any of the revenue
from tax coordination on rent creation.
The initial increase in public sector employment allowed by an internationally
coordinated rise in τ and the resulting effects on factor prices may be found
from the capital market equilibrium condition (2.12) and the government budget
constraint (2.22), using that W = w (r + τ) initially:17
|
dα |
εk (1 — α)2 wα α + εα-1 (1 - |
-α)2] |
- > 0, |
(4.3) | |
|
dr |
/ 1 + εα-1 (1 — α + εα-1 (1 — |
2 ∖2 |
< —1, |
(4.4) | |
|
dW |
dw |
=-k∙μι+dτ ) = |
k .. ------------------2 > o. α + εα-1 (1 — α) |
(4.5) | |
The derivative (4.5) gives the increase in the public sector wage rate that politi-
cians must grant to keep satisfying the recruitment constraint, but without offer-
ing any rents to public sector workers. The remaining part of the increase in tax
17We use the fact that, with symmetric countries and a harmonised capital tax rate which
is controlled by some international authority, the capital market equilibrium condition (2.12)
simplifies to equation (4.7) below.
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