Second, the covariance measures the correlation between the profitability ( f k!k )
and the elasticity of the marginal firms with respect to a, weighted by the tax base
((Fh — Kh} ^ʌ^ ). To get the intuition, consider the following example: Assume
that profitability increases in B. Assume further that the response of the dh-firms
rises with B as well. In this case, the covariance term is positive. That means
that, even if the average marginal firm profitability is equal to the average overall
firm profitability, the optimal strategy is a tax base with a < 1. The reason is
that among the marginal firms the highly profitable firms react more elastically to
tax base changes.
4 Discussion and concluding remarks
The analysis in the preceding section has shown that, under simple assumptions
on firm mobility, the efficiency property of undistorted investment in the optimal
tax system vanishes. How do our results relate to the literature, and what policy
implications do they have?
First, our results question the standard result that a consumption tax system is
desirable when capital is internationally mobile. The mobility of firms is a plausible
assumption and plays an important role in policy debates around the world. Our
model shows that a consumption tax which leaves the marginal investment untaxed
is the optimal policy response only in the special case where the marginal firm
(which is indifferent between staying and moving) is exactly as profitable as the
rest of the economy.
Second, our model can be understood as part of the literature that explains
observable inefficiencies in tax systems by the lack of appropriate instruments. In
the presence of internationally mobile firms the government would like to discrim-
inate between mobile and immobile firms. In this model we assumed that the
government faces informational or political constraints and has no means to do so.
Note that relaxing the assumption that the tax rate has to be equal for every
firm in the economy would allow for discrimination of firms according to their mo-
bility. It is straightforward to show that the optimal tax policy (i.e. maximization
of social surplus) would imply investment neutrality. The government would then
set individual tax rates for each firm such that each firm with a mobility above a
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