Hotelling Tax Competition

H

OTELLING

T

AX

C

OMPETITION

M

YRNA

W

OODERS

B

EN

Z

ISSIMOS

CES

IFO

W

ORKING

P

APER

N

O

. 932

C

1: P

F

A

2003

An electronic version of the paper may be downloaded

• from the SSRN website: www.SSRN.com • from the CESifo website: www.CESifo.de

CESifo Working Paper No. 932

H

OTELLING

T

AX

C

OMPETITION

Abstract

This paper shows how competition among governments for mobile firms can bring about excessive differentiation in levels of taxation and public good provision. Hotelling’s Principle of Minimum Differentiation is applied in the context of tax competition and shown to be invalid. Instead, when an equilibrium exists, differentiation of public good provision is maximized. Non-existence of equilibrium, which is possible, is a metaphor for intense tax competition. The paper also shows that, to some extent, perfect tax discrimination presents a solution to the existence problem created by Hotelling tax competition, but that the efficiency problem of Hotelling tax competition is exacerbated.

JEL Code: H1, H25, H73, H87.

Keywords: hotelling, limit tax, perfect tax discrimination, tax competion.

Myrna Wooders Department of Economics University of Warwick Coventry CV4 7AL United Kingdom [email protected] Ben Zissimos Department of Economics University of Birmingham Birmingham B15 2 TT United Kingdom [email protected]

We are especially grateful to Amrita Dhillon for useful comments and conversations about this paper. We also thank seminar participants at a European Science Foundation Workshop held at Paris 1 in June 2002. Financial support from the ESRC’s Evolving Macroeconomy Programme is gratefully acknowledged.

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