as the underprovision of public goods becomes more serious. In a quantitative
version of the model we trace the impact of increasing the number of competing tax
jurisdictions and rank different scenarios in welfare terms to identify the economic
and political conditions under which tax competition is preferable to autarky. Our
findings suggest that tax competition is a badly targeted remedy against political
distortions.
We then analyze the effects of international tax coordination on social welfare.
When individual countries are too small to affect the world interest rate, some
amount of international tax coordination will be welfare-improving under very
mild conditions. Indeed, we find that it may be welfare-enhancing to carry tax
coordination beyond the point where rents to public sector workers start to emerge.
In section 2 we set up our model. Section 3 analyses how the political equi-
librium is influenced by tax competition while section 4 studies how international
tax coordination affects rent seeking and social welfare. Section 5 summarises our
main conclusions, and three technical appendices document the results reported
in the text.
2. The model
We consider a world economy consisting of n symmetric countries. Residents in
each country can either work in the private or in the public sector, and they
consume private goods as well as a pure public good. Labour is the only input
into the production of the public good, while private goods are produced by means
of capital and labour. Capital is perfectly mobile across countries, whereas labour
is immobile internationally. There are no international spillovers from the supply
of public goods, but since public expenditure is financed by a source-based tax on
capital, there is a fiscal externality arising from interjurisdictional competition for
the mobile tax base. All countries produce the same good, so national tax policies
have no effects on the commodity terms of trade.
Politicians choose the level of taxation, the level of public service provision and
the public sector wage rate with the purpose of maximising the probability of being
voted into office. Voters are split into a group of well-organised ‘insiders’ employed
in the public sector and a group of non-organised ‘outsiders’ mainly employed
in the private sector. By increasing the economic welfare of the members of a