Commodity tax competition and industry location under the destination and the origin principle

Abstract

We extend the model by Behrens et al. [Behrens, K., Hamilton, J.H., Ottaviano, G.I.P., Thisse, J.-F., 2007a. Commodity tax harmonization and the location of industry. Journal of International Economics 72, 271-291.] to the case of non-cooperative commodity taxation and investigate the impacts of tax harmonization and changes in tax principle on equilibrium tax rates, industry location, and welfare. Since our setup features internationally mobile firms, trade frictions, and asymmetric country sizes, it offers a convenient framework within which to investigate how differences in market size and deepening international integration affect equilibrium outcomes under competing tax principles. The origin principle, when compared to the destination principle, is shown to exacerbate tax competition and to erode tax revenues, yet gives rise to a more equal spatial distribution of economic activity. This suggests that federations which care about spatial inequality, like the European Union, face a non-trivial choice for their tax principle that goes beyond the standard considerations of tax revenue distribution.