Trade, Capital Mobility, and Tax Competition

This paper examines a system of governments that finance public expenditures with taxes on mobile capital. Unlike previous research on "tax competition," expli cit consideration is given to the general-equilibrium determination o f the prices at which goods are traded between regions. The analysis identifies inefficiencies in government behavior that are not apparen t in models in which the terms of trade are exogenously given. Capita l taxation is shown to create an inefficient distribution of public-g ood outputs across regions, accompanied by an inefficient pattern of trade. A model is presented in which the chosen levels of public-good outputs differ across regions containing identical residents and pro duction possibilities.